STOCK US Federal Reserve
The exterior of the Marriner S. Eccles Federal Reserve Board Building is seen in Washington, D.C. Image Credit: Reuters

Inflation has lifted the cost of just about everything, pushing overall prices up 8.6% in the past year and leaving many people concerned with what Washington policymakers are doing about it.

The Federal Reserve, the nation's central bank, is charged with keeping prices stable and with keeping unemployment low. The bank has been moving to tackle the greatest run-up in prices in four decades. But many fear that their efforts to curb inflation have come too late.

This week, as Wall Street teeters and warnings of a potential recession grow, the Fed is under even more intense scrutiny. The central bank announced on Wednesday that it is raising interest rates by three-quarters of a percentage point in an attempt to temper record inflation.


The bank's aim is that inflation will stabilise over time without slowing economic growth too much and forcing job losses. But less rosy scenarios may materialise, including an economy defined by surging prices and clamped growth.

Three years into the pandemic and the unfolding economic turmoil it brought, the Fed is at another crucial turning point. Here's why:

Q: What will the Fed's rate hike mean for consumers?

A: Raising the federal funds rate, which the central bank controls, makes borrowing money more expensive. That has a direct impact on things like credit card bills, new car loans and mortgages, though the Fed doesn't set those interest rates itself. Some interest rates have already been rising, nudged up by the Fed's last increase and by the expectation of more hikes.

A broad range of economic challenges have raised fears of a recession. But economists and policymakers see conflicting signals: The U.S. unemployment rate remains extremely low, and consumers have continued to spend, which underscores the health of the economy.

But inflation has persisted much longer - and at much higher rates - than Fed officials had initially thought, squeezing consumers' and businesses' budgets and prompting further action.

Q: How does raising interest rates slow inflation?

A: By raising rates the Fed will make borrowing more expensive, which discourages consumers from making large purchases and compels people to pull back on spending. The goal is to lower demand over time, allowing prices to come down and stabilize.

This power to set interest rates is one of the Fed's main tools to steer the nation's economy. The Fed can lower rates, making it cheaper to borrow, which encourages economic activity by spurring spending and investments. When the pandemic first plunged the global economy into a crisis, as businesses, government offices and schools closed, the Fed cut interest rates to near zero, a tactic many central banks had also used after the financial crisis in the mid-2000s. That made it less expensive for consumers to get a car or home loan and made other major purchases easier to come by.

But since climbing out of the COVID recession, the economy faces new challenges. Inflation is at a 40-year high. Gas prices have surpassed $5 a gallon. And supply disruptions continue to plague businesses and consumers. So instead of cutting rates to encourage growth, the Fed is now trying to reverse course and cool the economy.

Q: Will raising rates cause a recession?

A: It's possible. The Fed's goal of lowering inflation comes with a major risk: Pushing rates up could slow growth too much and too fast, leading the country into a recession.

Central bankers have acknowledged that bringing prices down requires a delicate balance. Getting rates, prices and growth just right would be a "soft landing," the Fed's stated goal. But slowing the economy too much and bringing on a severe recession could lead to layoffs. That's part of what happened the last time inflation was as high as it is now, in the early 1980s, when the Fed tightened the money supply aggressively to control price increases - interest rates eventually got near 20%, and unemployment hit close to 11%. Inflation subsided, but the recession then was the worst since the Great Depression until the financial crisis earlier this century.