Inflation and Interest Rates: What Happened, What They Mean, and How We Can React To Them

The largest jobs-and-the-economy news story of 2022 is clearly here.  There has been almost too much coverage and commentary, even when it’s not politically distorted.  So let’s go to the core.

Per Jeanna Smialek’s May 4^th New York Times “Fed raises rates half a percentage point, its largest increase since 2000,” the federal funds target level went up last week, though at 1.00% it is historically low, in fact under any point from before 1970 to 2002.  We should expect more such hikes, as Federal Reserve chair Jerome H. Powell said that “there is a broad sense on the committee that additional 50 basis points increases should be on the table at the next couple of meetings.”  The Bureau of Labor Statistics announced that “inflation edged down to 8.3% in April compared to a year ago, remaining near 40-year highs” (The Washington Post, May 11^th), from 8.5% in March, suggesting that the rate, if still a major problem, is leveling off or decreasing.

One of higher prices’ less-publicized effects is that “Sky-high inflation could lead to higher taxes for millions of Americans” (Megan Henney, Fox Business, May 10^th).  Since federal income tax became indexed in 1981, we haven’t thought much about “bracket creep,” the result of pay following higher prices being subject to percentage tax increases, but “15 states fail to account for inflation when drawing the brackets for taxes on wages and income” and “another 18 states do not index personal exemption tax to inflation.”  These locations are spread all over the country, and the first group includes high-population Georgia, New Jersey, and New York.  With the current problem small for four decades, this situation was given little priority, but expect that to change.

“What do Federal Reserve interest rate hikes mean for Main Street?” (Brock Dumas, Fox Business, March 16^th).  That includes higher personal rates on “car loans, mortgages, and credit card balances,” but those for “savings accounts and CDs will rise at a slower pace.”  Discouraging, but to be expected. 

What else can ordinary people do?  The advice offered in “Gas prices could hit a new record high:  Here’s how to save” (Daniella Genovese, Fox Business, May 9^th) is well-worn, but bears repeating:  “Lighten the weight of your car”; “Purchase a fuel-efficient car”; “Only use the air conditioning when you need it”; “Use cruise control”; “Don’t idle”; “Make sure your tires are properly inflated”; “use cash-back credit cards and… join a gas station loyalty program when possible.”  These things matter more than usual.  I add that when deciding whether to pay with cash or credit when the latter costs more, consider what your cash-back rate is, as often now the difference at the pump is less than 1%. 

A new opportunity, perfect for now, was described by Ann Carrns in the May 3^rd New York Times: “Inflation bonds are earning eye-popping rates:  9.62 percent.”  Seems too good to be true, but these are legitimate Series I U.S. savings bonds.  They pay amounts algorithmically determined from fixed amounts and inflation levels.  They must be bought online, with limits of $10,000 per person plus a maximum of $5.000 more with tax refund money, “you must hold I bonds for at least 12 months before redeeming them, and you’ll be docked the last three months of interest as a penalty if you redeem before five years.”  If you don’t believe it, check out treasurydirect.gov and open an account for yourself to start the process, which takes at least ten business days.  I did.

In government policy as elsewhere, the strongest response is not always the best.  That was the idea of “The Courage Required to Confront Inflation,” by the New York Times Editorial Board on April 29^th.  Points made in this piece include “supply shortages… are best endured patiently.  The Fed’s decision… won’t ease them,” “lingering questions about the health of the economy provide another reason for the Fed to move cautiously,” and “there is no evidence the United states is entering a wage-price spiral.”  Sellers are all too willing to get more products, and when the problems from supply-chain snags to Covid-19-caused foreign worker restrictions ease, they will come in no matter the interest rates.  In the meantime, jobs are plentiful and families have added a lot of money, two things we don’t want to endanger.  The course we are following is prudent and will prove effective – let us give it the time it needs.