A perfect storm has been brewing in the U.S. economy. Supply constraints coupled with increased demand built up during the pandemic have led to rapid inflation. The Fed is now taking action by raising interest rates significantly, a move that has many worried about the impending recession soon to follow. While a housing market crash is not anticipated,\u00a0<\/span>economists are predicting<\/span><\/a>\u00a0more inventory and a cooling market due to the interest rate hikes.\u00a0<\/span><\/p>\n In an episode of BiggerPockets\u2019\u00a0<\/span>On the Market Podcast<\/span><\/a>, we spoke with Nick Timiraos, Chief Economics Correspondent for The Wall Street Journal, to get his thoughts on the Fed\u2019s plans now that the Fed has\u00a0<\/span>increased its interest rate by 0.75%<\/span><\/a>, the most aggressive increase since the 1990s.<\/span><\/p>\n Timiraos says to think of the Federal Reserve System as \u201ca bank for banks,\u201d because the Fed controls short-term interest rates. The Fed doesn\u2019t directly set mortgage rates but determines the interest rate banks pay to borrow from their reserves overnight.\u00a0<\/span><\/p>\n The Fed is charged with the difficult task of monitoring and maintaining the economy\u2019s health in a couple of ways. \u201cThey have two goals assigned to them by Congress: to maintain stable prices and to have maximum employment,\u201d explains Timiraos. \u201cAnd you could think of that as the most employment possible without having inflation. And those are their two goals. And then, in addition to all of that, they\u2019re charged with regulating the banking sector.\u201d<\/span><\/p>\n When the Fed reduced interest rates at the onset of the pandemic, they were trying to stimulate the economy. As they increase interest rates like now, they\u2019re doing it to slow down inflation, which inevitably slows down the economy.\u00a0<\/span><\/p>\n The problem started with the $5 trillion stimulus package for pandemic relief. The federal government\u2019s response resulted in much higher inflation than we currently see in other countries. In the short term, it may have appeared that they achieved the intended result of providing more financial stability to families. But national debt must be repaid. The government must, at some point, tax more than it spends. Federal Reserve\u00a0<\/span>economists estimate<\/span><\/a>\u00a0that pandemic spending contributed about three percentage points to the inflation we are experiencing now.\u00a0<\/span><\/p>\n In the long run, any government attempt to stimulate the economy by creating money without also increasing production leads to harmful inflation. But the impact of the pandemic was so swift and far-reaching that it would have led to deflation if the government hadn\u2019t stepped in. And meanwhile, food and housing insecurity was rising. About\u00a0<\/span>one in five<\/span><\/a>\u00a0children may have experienced food insecurity during 2020. So despite knowing that distributing more money into the economy would debase the currency, the federal government was most concerned with the greater implications of starving children and broad housing insecurity.<\/span><\/p>\n Then, when lockdowns were lifted, there was a pent-up demand for goods and services, along with extra money for consumers to spend. \u201cYou have a lot of demand. You have more people working, making more money, spending money on things,\u201d says Tirimaos.\u00a0<\/span><\/p>\n But, at the same time, global supply chain issues have prevented producers from keeping up with demand. That\u2019s pushed the inflation rate to 8.6%, according to\u00a0<\/span>May\u2019s CPI report<\/span><\/a>, and now the Fed will do whatever it can to keep that rate from rising.\u00a0<\/span><\/p>\n \u201cThe Fed can\u2019t do a lot in the near term about the supply side of the economy,\u201d explains Tirimaos. \u201cThey can\u2019t create more oil, they can\u2019t create more houses, their tools just don\u2019t do that. So when they talk about bringing supply and demand into balance, they [need] to get lucky, they need to get supply chains moving again.\u201d\u00a0<\/span><\/p>\n Or, they need to do something to curb demand so that a balance between supply and demand can be achieved.\u00a0<\/span><\/p>\n That\u2019s the goal of raising the benchmark interest rate. When the Fed\u2019s rate rises, its effect spreads into the mortgage market, the auto market, and increases the cost of borrowing business loans. Overall, people become less likely to borrow and purchase homes or vehicles. \u201cAnd also businesses hire fewer workers. And so people have less overall income. And so they don\u2019t spend as much money,\u201d says Timiraos.\u00a0<\/span><\/p>\n If inflation has been a problem since last year, why is the Fed suddenly getting aggressive with interest rate hikes?\u00a0<\/span><\/p>\n During the pandemic, specific supply-constrained industries, such as new and used cars, saw the highest price increases. \u201cAnd so for a while, of course, the Fed infamously said, and a lot of private sector economists agreed that this was transitory,\u201d says Timiraos. \u201cThe idea behind that was that inflation was really driven by the pandemic. And assuming the pandemic was over with quickly, inflation would be too.\u201d\u00a0<\/span><\/p>\n But more fuel has been added to the fire since then. The war in Ukraine caused inflation in the global energy market and supply chains never recovered as well as they needed to. The problem no longer seems transient, which has the Fed concerned.\u00a0<\/span><\/p>\n \u201cThey\u2019re worried that one year of high inflation is okay, but if we have a second year of that, people are going to begin to build expectations of higher prices into their wage setting and price setting behaviors. And that psychology is something the Fed really strongly wants to avoid.\u201d<\/span><\/p>\n The Fed\u2019s goal now is to achieve a neutral interest rate, says Tirimaos. \u201cA neutral interest rate is the level the Fed thinks isn\u2019t providing any stimulus to the economy. If you think of the economy as a car and the Fed is the driver, they\u2019re taking their foot off the gas. They\u2019re not pushing on the brake, but they\u2019re trying to find that place where they\u2019re no longer pushing on the gas, not necessarily stepping on the brake.\u201d<\/span><\/p>\n The Fed is \u201cnot trying to induce a recession,\u201d\u00a0<\/span>says Federal Reserve Chair Jerome Powell<\/span><\/a>. But it will do whatever it takes to slow down the overheating economy, which could very well implicate a recession.<\/span><\/p>\n Real estate appreciation isn\u2019t factored into the Fed\u2019s assessment of inflation, but the Fed is charged with overseeing the financial system\u2019s stability. So in that way, Tirimaos says, they\u2019re concerned about rapidly rising asset prices. \u201cNow, there\u2019s been a big debate over the last 10 years which is: should the Fed raise interest rates even if inflation\u2019s contained and even if they\u2019re meeting their mandate unemployment, but to prick a bubble? Because an asset bubble could jeopardize their ability to achieve both of their other goals. And the argument has generally been, no, we shouldn\u2019t use interest rates. We shouldn\u2019t raise interest rates to prick asset bubbles.\u201d<\/span><\/p>\n But in 2022, inflation is so high that the Fed needs to raise interest rates regardless. Curbing the asset price boom simultaneously is a \u201chappy coincidence\u201d rather than a direct goal.\u00a0<\/span><\/p>\n Still, a cooling housing market aligns with the Fed\u2019s goals. \u201cThey want [economic] activity to cool, they want to remove some of that excess demand that you have right now. And so if you\u2019re in situations where homes that used to be getting 10 or 30 offers are now getting three or four, for the Fed, that\u2019s probably a healthy development.\u201d<\/span><\/p>\n The Fed is attempting a \u201csoft landing\u201d that won\u2019t result in a recession, but the\u00a0<\/span>chances of this are slim<\/span><\/a>, with history as a guide. Dave Meyer, VP of Analytics at BiggerPockets,\u00a0<\/span>writes<\/span><\/a>, \u201cAs the Fed raises rates, many parts of the economy will be negatively impacted.\u201d These include a falling stock market and a loosening labor market. \u201cWith all these factors converging, I believe a recession will likely come in the next couple of months.\u201d\u00a0<\/span><\/p>\n The best thing Americans can do in preparation for a recession is to save aggressively and invest for the long term. Experts recommend adjusting your budget to bolster your emergency fund in anticipation of layoffs. Once your emergency fund is adequately funded, invest in the stock market while prices are low\u2014or invest in real estate, which is typically more stable.\u00a0<\/span><\/p>\n Investors relying on mortgages to make deals will have their margins constrained by rising mortgage rates, so they\u2019ll need to factor that into investment decisions. Make sure the deal is profitable with the current rate, but remember that refinancing may help increase your profit margins later on if we see interest rates fall again.<\/span><\/p>\n Fundrise is revolutionizing how you invest in real estate.<\/strong><\/p>\n With direct-access to high-quality real estate investments, Fundrise allows you to build, manage, and grow a portfolio at the touch of a button. Combining innovation with expertise, Fundrise maximizes your long-term return potential and has quickly become America\u2019s largest direct-to-investor real estate investing platform.<\/p>\n Learn more about Fundrise<\/a><\/div>\n<\/div>\n<\/div>\n<\/div>\nThe Difficult Task of the Federal Reserve<\/span><\/h2>\n
What is Causing Inflation?<\/span><\/h2>\n
Why the Fed is Taking Action Now<\/span><\/h2>\n
What About Asset Prices?<\/span><\/h2>\n
What This Means for Consumers and Investors<\/span><\/h2>\n
On The Market is presented by Fundrise<\/strong><\/h3>\n
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