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Here’s the Federal Reserve’s best tool against inflation — and how it has worked for 40 years

The federal funds rate, and interest rates across the country, will increase again as the Federal Reserve seeks to bring down record-high inflation.

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As Chairman Jerome Powell and the Federal Reserve Board meet today to decide how much higher to raise interest rates, two numbers will likely weigh heavily on their decision: the inflation rate and the unemployment rate.

The Federal Reserve has two broad goals: ensure price stability (which has generally been 2% inflation) while achieving maximum employment – a bit of a squishy term for trying to keep as many people employed as possible.

The Fed's primary tool for balancing these competing goals is the federal funds rate. It's the interest rate banks charge one another for overnight loans. As borrowing money gets more expensive for banks, it gets more expensive for the rest of us. So what does the data say about these two key numbers? 

US inflation rate still at 40-year highs

Months after the COVID-19 pandemic upended the U.S. economy, members of the Federal Reserve board assured Americans that the higher prices would soon pass. But as prices we pay for items such as cars, groceries and energy rose toward 40-year highs, the board's tone changed.

In late August in Jackson Hole, Wyoming, Powell told attendees at an annual conference that “restoring price stability will likely require maintaining a restrictive policy stance for some time."

Those words have signaled that Fed policymakers are still concerned about inflation, which, in turn, has worried investors who have driven down stock prices over concerns that the economy might enter a recession if the Fed continues to raise rates.

Unemployment rate near pre-pandemic levels

Some say we might already be in a recession because the nation's gross domestic product, a comprehensive measure of U.S. economic activity, has fallen in two consecutive quarters. That's the unofficial definition of a recession, but it's difficult to square with the strong job growth in those two quarters. A first look at third-quarter GDP will be released next week. The Atlanta Fed's GDPNow model is forecasting a 0.3% growth rate for third-quarter GDP.

Even with multiple rate increases this year, the unemployment rate is a couple of ticks above the February 2020 rate, and employers are still looking to hire. The country's largest job site Indeed reported on Aug. 19 that its overall job postings were up 50.5% from Feb. 1, 2020, and new postings were up 61.6%.

So where does that leave the Fed?

What the Fed has done about inflation in the past

The pandemic caused a tragic loss of life in the U.S. and around the globe. It also devastated the American economy.

U.S. unemployment spiked as many parts of the economy shut down in March and April 2020. To stave off severe damage to the economy, the Federal Reserve quickly cut interest rates to 0-0.25% while the federal government pumped trillions of dollars of money into the economy through multiple pandemic relief measures.

Home sales might be one of the initial signs that the Federal Reserve's rate increases (or tightening) are slowing the economy. Thirty-year mortgage rates are about double what they were last year, raising buyers' monthly mortgage payments.

Sales of existing homes fell 0.4% from from July to August, the National Association of Realtors said Sept. 21. That's the seventh straight month that sales have declined in an important U.S. industry. Home construction and sales account for about 4% of GDP.

Recent measures of consumer spending, though, suggest the Fed might have more work ahead to slow the economy and inflation.

Retail sales rose in August

Retail sales increased in August as falling gasoline prices drew Americans back into stores and restaurants. The spending gain was higher than expected, even though inflation increased prices of food and rent.

Much of the increase was attributed to more spending on vehicles.

Here's what the Federal Reserve's key interest rate hike means for your finances
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SOURCE USA TODAY Network reporting and research; Federal Reserve; Commerce Department; Associated Press

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