What can douse fiery inflation?
On June 10, 2022, the U.S. Bureau of Labor Statistics released a report showing that inflation hit 8.6% in May, representing the largest 12-month increase since December 1981 and far exceeding the Federal Reserve’s target of 2% inflation. With fuel prices reaching record highs and bearish sentiment throughout the stock market, the economic outlook is starting to sour.
The Wall Street Journal recently conducted a survey of economists and found that they believe there is a 44% chance of recession in the next 12 months, up from 28% in the Journal’s April 2022 survey.
“When it gets that high, it basically means we’re either in a recession already, or one is coming,” says Wayne Winegarden, senior fellow in business and economics at the Pacific Research Institute.
With the economy facing headwinds thanks in part to soaring inflation, both consumers and businesses will see an erosion of their finances and ability to plan for the future.
Interest rates and inflation
One tool the Fed has to fight inflation is through adjusting the federal funds rate, which impacts how expensive it is to borrow money. When rates are low, a loan to buy a car, business equipment or home is cheaper since less of the total cost will go to interest. Higher rates, on the other hand, make borrowing more expensive, which has a cooling effect on the economy. Since inflation is commonly thought of as “too much money chasing too few goods,” discouraging spending through higher interest rates helps tame prices spiraling upward.
For example, Stewart Willis, co-founder and co-owner of Asset Preservation Tax & Retirement Services, says Arizona’s housing market is starting to stabilize due to the Fed’s recent moves.
“Because interest rates are rising, we’re going to see downward pressure of housing prices,” he says. “With all things remaining the same, a higher mortgage rate will make the mortgage more expensive, so people can afford less house. We started getting into Monopoly money numbers when it came to housing because you could get a 30-year mortgage at 2.5%.”
READ ALSO: Metro Phoenix No. 1 in the nation for highest inflation
Say someone takes out a 30-year, fixed rate mortgage for $500,000 at a 2.5% interest rate to buy a house. The total cost over the life of the loan is $711,323. If that rate goes to 5%, the total sum owed jumps to $966,330. For the buyer to pay approximately the same total cost at a 5% interest rate, they can only afford a $370,000 mortgage — meaning that interest rates have a direct relationship with purchasing power and prices.
To that end, the Fed increased the federal funds rate by .75% during its June meeting — the most aggressive hike since 1994. One concern is that by raising rates too quickly, it will induce a recession.
“In my viewpoint, [the Fed isn’t] going to be able to thread the needle, because the genie is just too far out of the bottle,” Winegarden says. “Whether you want to call it a recession or not, you’re getting a squeeze in what economists would call the ‘real economy.’ It affects our daily living, but it’s also hitting small businesses. They’re in a terrible position to manage the costs compared to large companies.”
Businesses to blame?
When times get tough, it’s a natural human response to look for someone or something to scapegoat. There’s a small satisfaction in knowing, despite the unhappiness, that there is a root cause to point to. In today’s inflationary environment, the business community has become a popular boogeyman to lay blame upon for the U.S.’ economic woes. Accusing businesses of being the cause of inflation is a category error, according to Winegarden.
“Imagine if businesses all of a sudden started to become greedy, and they all raise their prices. If incomes [are stable] and the money supply isn’t growing, we couldn’t buy anything,” he explains. “You physically can’t devalue the dollar through inflation [due to] companies raising prices, because you can’t simultaneously raise every price. The only way you could do that is through excessive money creation.”
When it comes to picking on companies, Winegarden notes that people often shoot the messenger. There are, however, many costs incurred by businesses during the initial inflationary phase, after which profits are likely to increase — followed by a crash.
“People only tend to remember that profits swung up,” Winegarden says. “Greed is a constant, like gravity, so it’s not something that’s changed that can explain inflation. I am not trying to be naïve to think that companies aren’t trying to raise prices, of course they are, but that’s the push and pull of a healthy market dynamic. People push back and end up with equilibrium prices.”
Some companies, he continues, are starting to slow down hiring, and there are whispers about layoffs.
“You have the businesses that are beginning to buckle, you have consumers that are beginning to buckle,” Winegarden concludes. “I look at all of that and see that we’re hitting a very rough patch. I’d say we will be in a recession at some point in the near future, if we’re not already in one. We’re feeling those consequences, and they’re only going to get worse.”