Understanding the Fed’s Current Monetary Policy

The Fed will likely raise interest rates three or four times before the end of the year.

The Federal Reserve said earlier this year, that they are switching their focus from primarily reducing unemployment to reducing inflation which now exceeds 9%. As a result, the Fed is rapidly increasing interest rates. How did the high inflation happen? Why will raising interest rates reduce inflation? How long until inflation is reduced?

Inflation simply means generally rising prices. Prior the pandemic inflation, as measured by the Consumer Price Index (CPI), had been in the 2% range. Now it exceeds 9%. Prices rise for only one reason. That is, at the current price, consumers are willing and able to purchase more goods and services than business is willing and able to provide.

That situation occurs when there is excess demand in the economy and/or when there is a reduction in business’ ability to supply, which is usually brought on by higher resource prices or less availability of some resources. Today’s inflation is mostly due to excess demand and partially due to rising resource prices that reduce business’ ability to profitable supply.

On the supply side, today’s inflation is caused by policy actions that reduced the supply of energy. That caused energy prices to rise, which affects the price…