**Title: The Federal Reserve Pauses Rate Hikes Amid Decreasing Inflation: Is it Time for a Permanent Stop?**
**Is Inflation Lower Than It Appears?**
The Federal Reserve’s decision to keep interest rates steady indicates a temporary pause in its aggressive approach to controlling inflation. However, recent data suggests that this pause may evolve into a more permanent stance. Key indicators, such as the consumer price index, reveal that inflation is actually lower than it seems.
The latest consumer price index data, released on June 13, shows that core inflation, which excludes volatile food and energy prices, fell to a yearly rate of 5.3% in May 2023. This is the slowest pace since November 2021 and a significant decrease from its peak of 6.6% in September 2022. Though inflation remains above the Fed’s target rate of 2%, there are indications that it will continue to decline regardless of the central bank’s actions.
Shelter costs, the largest component of the consumer price index, make up over a third of the total. The Bureau of Labor Statistics reports that shelter costs rose 8% from a year ago, but this data does not reflect the reality of the current housing market. The survey conducted by the Bureau relies on rental prices from leases signed during the rental bubble in 2021 and 2022. An alternative measure, the Zillow Observed Rent Index, suggests that rental rates are actually declining. Comparing these two measures reveals a lag of four to six months in the official consumer price index data. Using current rental rates would place inflation closer to the Fed’s target.
Jason Furman, former chair of the government’s Council of Economic Advisors, has created a modified version of core inflation that utilizes a market-based measure of shelter prices. This modified measure places core inflation at a lower rate of 2.6%.
**The Risk of Further Rate Hikes**
Continuing to raise interest rates may do more harm than good, particularly to the banking sector. Several regional lenders, including Silicon Valley Bank and First Republic, collapsed earlier this year due to bank runs. The aggressive rate hikes implemented by the Fed caused the value of their assets to plummet, contributing to their downfall. These banks primarily served depositors with accounts that exceeded the insured threshold of $250,000, resulting in a mass exodus of depositors when they discovered the extent of the bank losses. Additionally, higher interest rates have had a cooling effect on business activity.
The banking sector faces additional challenges, with approximately $1.5 trillion in commercial real estate loans requiring refinancing in the next three years. The combination of already high interest rates and low office occupancy rates will likely result in significant loan losses for banks, potentially pushing more institutions toward failure. Continuing to raise rates will only exacerbate this situation.
**Avoiding Past Mistakes**
In the past, the Federal Reserve has been slow to react to rising inflation and did not fully recognize the impact of rental rates on inflation. The decision to pause rate hikes in June allows the Fed an opportunity to review the data and reconsider its approach. It is essential that the central bank learns from its past mistakes and realizes that inflation is closer to its target than previously believed.
If the Fed chooses to proceed with further rate hikes, it risks repeating the errors made in the past. It is crucial for the central bank to carefully assess market conditions, consider the risks to the banking sector, and make informed decisions that prioritize stability and economic recovery.
**About the Author**
Ryan Herzog is an Associate Professor of Economics at Gonzaga University. This article is republished from The Conversation under a Creative Commons license. Read the original article.
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