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The Fed's hot pause summer gets an ice bath: Interest rates rise again

Federal Reserve Chairman Jerome Powell attends a meeting at the Spain's Central Bank in Madrid, Spain, Thursday, June 29, 2023.  In the U.S., Powell and the central bank are trying to navigate a "soft landing" for the economy.
Manu Fernandez
Federal Reserve Chairman Jerome Powell attends a meeting at the Spain's Central Bank in Madrid, Spain, Thursday, June 29, 2023. In the U.S., Powell and the central bank are trying to navigate a "soft landing" for the economy.

Updated July 26, 2023 at 5:53 PM ET

Pack up the umbrella and the beach towel and head back to the car: The Fed's Hot Pause Summer is officially over.

The Federal Reserve announced on Wednesday it would raise interest rates a quarter percentage point (or 25 basis points), to a 22-year high. It marks a return to the long, steady climb interest rates have been on for the last year, as the Fed attempts to beat back inflation.

"Inflation has moderated somewhat since the middle of last year," Fed Chair Jerome Powell said at a press conference.

"Nonetheless, the process of getting inflation back down to 2% has a long way to go."

Last month, Federal Reserve chair Jerome Powell hit the pause button on those rate hikes, which was like an economic beach holiday for consumers and Wall Street.

It meant credit card interest rates wouldn't keep rising and that loans people and businesses wanted to take out for things like houses weren't getting more expensive by the day.

And, even with the interest rate steady, inflation continued to fall, to roughly 3% (very near the Fed's goal rate of 2%) and the unemployment rate remained near historic lows.

Why is the Fed back to raising rates?

After nearly a year of aggressive action and rates at decades-long highs, why not keep the pause in place?

"I think the message they wanted to send is that things are moving in the right direction, but we need to wait and see," says economist Raghuram Rajan, former head of India's Central Bank and professor at The University of Chicago's Booth School of Business.

"Rather than, 'We're done,' they're waiting to see how the economy reacts and then deciding how much more medicine it needs," he says.

The Fed is trying to strike a tricky balance right now, Rajan says, what economists often call a "soft landing": Raising interest rates just enough to slow the economy down to where inflation falls, but not so much that the economy ends up in a recession.

Powell stressed at the press conference that it's important not to declare victory over inflation too soon.

"It's really a question of how do you balance the two risks, the risk of doing too much or doing too little," he said.

The Fed's tricky balance

When interest rates rise, people and businesses have to pay more on their loans. They then borrow — and spend and buy — less. Companies sell less stuff because there are fewer buyers, and that usually brings prices down. And, voila: Inflation comes down.

The trouble is, when companies make less money, they also don't expand, and will often lay people off. Those things can cause a recession.

Now that things are moving in the right direction, says Rajan, the Fed probably doesn't want to take its foot off the brake and risk inflation getting out of control.

Then the U.S. will be caught in the dreaded inflationary spiral.

For Powell this is the top priority, because "the worst outcome for everyone would be not to deal with inflation now and not get it done," he said on Wednesday.

The cautionary tale

An inflationary spiral took hold of the U.S. economy back in the 1970s and the Fed had to take aggressive action that caused a deep recession and high unemployment for years.

Right now, in spite of everything looking good, it's important for the Fed to be cautious, says economist Matthew Slaughter, Dean of Dartmouth's Tuck School of Business.

"I've always been Team Soft Landing, aspirationally," he says. "But the empirical economist in me thinks that's pretty unlikely."

Slaughter points out that historically, when countries try to get back to a low target inflation rate, it almost always causes a lot of people to lose their jobs.

Powell seemed to agree with this cautious take.

"We have to be honest about the historical record," he said at the press conference, "which does suggest that when central banks go in and slow the economy to bring down inflation, the result tends to be some softening in labor market conditions."

In other words, getting inflation where we want it without causing a recession would make us exceptional.

The economy on ice

Slaughter says big economic actions, like raising interest rates, can take time to play out. He compares monetary policy to the sport of curling, which was popular in Minnesota, where he grew up:

"You've got the puck... and you push it and the team can try and direct it and brush the ice... but in the end, they just have to wait and watch it move down the ice," he says.

The Fed stressed this, saying: "The Committee is strongly committed to returning inflation to its 2% objective."

Powell said he will be watching the data month to month and making decisions based on that alone. That means we could be in for more pauses and more rate hikes as the year plays out.

"It's really dependent so much on the data," said Powell. "And we just don't have it yet."

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Stacey Vanek Smith is the co-host of NPR's The Indicator from Planet Money. She's also a correspondent for Planet Money, where she covers business and economics. In this role, Smith has followed economic stories down the muddy back roads of Oklahoma to buy 100 barrels of oil; she's traveled to Pune, India, to track down the man who pitched the country's dramatic currency devaluation to the prime minister; and she's spoken with a North Korean woman who made a small fortune smuggling artificial sweetener in from China.