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Saturday, September 23, 2023

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Higher Monthly Mortgage or Less Expensive Home?: Inflation Q&A with SDSU's David Ely

The Federal Reserve vows to fight inflation, but what does that mean to rates and when will we see relief?
By Mario Sevilla

The Federal Reserve raised rates Wednesday by three-quarters of a point in its fight to neutralize unrelentingly high inflation. The reserve's committee unanimously agreed to lift its short-term rate to between 3% to 3.25%, its highest level in 14 years.

In Wednesday's meeting, central bank officials also warned of future rate hikes, by at least a full point by the end of the year, if inflation gains momentum. Federal Reserve Chairman Jerome Powell reiterated to reporters that the goal is to bring “inflation back down to 2%.”

"If we were to fail to do that, that would be the one thing that would be most painful for the people that we serve. So, for now, that has to be our overarching focus," said Powell.

The news is spurring questions concerning impact and challenges. For answers, SDSU NewsCenter talked with David Ely, Associate Dean for Academic Affairs in the Fowler College of Business.

What is the goal of these rate hikes and how do they work to curb ongoing inflation?

The goal of the rate hikes is to return the inflation rate back to the Federal Reserve’s target of 2%.  A healthy economy requires price stability.  Based on the Consumer Price Index, prices were 8.3% higher in August 2022 than in August 2021.  The latest Personal Consumption Expenditures Price Index also indicates inflation is running well above the Fed’s goal for price stability.  Federal Reserve board members and bank presidents who set monetary policy have raised their projections for inflation for 2023 and 2024.  Higher interest rates should work to decrease demand by raising the cost of borrowing for individuals and businesses.  Higher rates impact individuals who are taking on debt through credit cards, mortgages, auto and other types of loans.  Lower demand for goods and services throughout the economy should ease pressure on prices. 

Prices of consumer goods continue trending up in numerous categories. Will today's hike bring relief right away? 

The Federal Reserve started raising rates in March 2022 and has signaled that additional rate hikes are likely through the end of the year.  Inflation has moderated slightly but is still far too high. Relief from inflation is still months away. However, inflation should continue to ease over the next two years. Federal Reserve board members and bank presidents who set monetary policy issue a quarterly Summary of Projections.  In the September release, their median projection for inflation is 2.8% for 2023 and 2.3% for 2024.  If these projections prove correct, then inflation will not return to a more normal level until 2024. Relief from high prices will also depend on factors outside the control of the Federal Reserve, including supply-chain efficiencies and Russia’s war against Ukraine.  
For those hoping to purchase a home, what should they know? 

According to Freddie Mac, the average rate on a 30-year mortgage increased to 6% this month.  Thus, individuals looking to buy a home will need to choose between higher monthly mortgage payments or a less expensive home.  However, higher mortgage rates will lead some prospective buyers to give up their search.  Home prices in some areas are likely to decline as a result. 

There's growing interest in savings bonds and treasury inflation-protected securities (TIPS). Why are they popular right now? 

Series I savings bonds and TIPS attract fewer investors when inflation is low and stable since there is less need to seek protection against inflation.  However, now that inflation is high, choosing securities that offer inflation protection makes more sense. The rates on many savings vehicles available from financial institutions are insufficient to compensate for inflation.  Individuals may be more cautious about investing in stocks given the performance of stock markets this year.  So, the attractiveness of Series I savings bonds and TIPS is probably greater than it has been for decades

When will the Federal Reserve stop increasing rates?
In the latest Summary of Projections report, Federal Reserve officials project that the federal-funds rate target will be increased further in 2022 and again in 2023.  The median projection by officials for the target rate at the end of 2023 is 4.6%.  If these projections prove correct, then the Federal Reserve could stop increasing rates sometime in the first half of 2023.