Are the Federal Reserve’s High Interest Rates Working as Intended?

As inflation simmers down and the economy slows, the Federal Reserve’s monetary policy seems to be doing exactly what it was designed to do.

The Federal Reserve has pushed its influential interest rate to a 23-year high, making borrowing more costly and discouraging spending to tame inflation. However, in the first quarter, inflation grew, surprising economists and sparking fears that price pressures weren’t letting up.

Reigniting inflation caused some market watchers to question whether the Federal Reserve’s monetary policy was restrictive enough—and namely, if its influential fed funds rate was high enough. Even one central banker posited earlier this year that rates may have to rise further to achieve the Fed’s annual goal of 2% inflation.

Price Pressures Easing

However, economic data since then has shown price pressures are easing and spending is cooling off across sectors.

“It’s really challenging to look anywhere and not see monetary policy working,” said San Francisco Federal Reserve Mary Daly in an interview on CNBC last Friday after the release of the Fed’s preferred gauge of inflation.

Prices as measured by the Personal Consumption Expenditures index moved a negligible amount in May and represented the slowest pace of monthly inflation since November. The index also showed that prices rose 2.6% over the same time last year, putting the annual rate closer to the Fed’s 2% target.

“We have growth slowing, spending slowing, the labor market slowing, inflation coming down. That’s how policy works,” Daly said. “Now, it’s taking longer than we’d all like, of course, but that doesn’t mean it’s not working.”

High Interest Rates Have Widespread Impact

The effects of the Federal Reserve’s fight against inflation are finally being seen across the economy. After being resilient in the face of high interest rates, consumer and business spending is slowing.

Businesses are building fewer structures, a sign that companies are putting the brakes on capital expenditures. Meanwhile, manufacturing companies are receiving fewer orders, citing weakening demand.

Consumer spending has buoyed the economy in the pandemic recovery but has started to slow in recent months. Economists predict shoppers will moderate their spending through the remainder of the year.

“The latest snapshot of consumer behavior portrays an economy that is gliding towards the much-heralded soft landing,” wrote Senior Economist Bob Schwartz with Oxford Economics.

So When Will the Fed Cut Interest Rates?

While Fed officials have acknowledged progress in the fight against inflation, they have said they need to see more data before beginning to cut interest rates.

“We want to be more confident that inflation is moving sustainably down toward 2% before we start the process of reducing how tight our policy is,” Fed Chair Jerome Powell said Tuesday during a panel discussion at a European Central Bank conference in Portugal.

If the Fed cuts too soon, inflation could rebound, forcing the central bank to reverse course and hike rates again. If the Fed waits too long to cut, it could result in higher unemployment.

“We have to balance the two, and given the strength in the economy, we can approach that carefully,” Powell said.

Chicago Federal Reserve Bank President Austan Goolsbee said the Fed should be ready to act on interest rate cuts if the job market weakens. “There’s a danger from waiting and there’s a danger from making wrong moves,” Goolsbee said in an interview with Bloomberg TV Tuesday.

The comments come ahead of the release of the June payroll report on Friday, where officials will be closely watching to see if the labor market continues to outperform expectations.