How high, and for how long, can the Fed raise interest rates?

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Phyneas
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How high, and for how long, can the Fed raise interest rates?

Post by Phyneas »

If inflation persists at these levels for longer than they'd like, or continues to rise, and the planned interest rate hikes are, or at that point, will have been, ineffective in tamping it down, how much headroom does the Fed have to raise interest rates before the debt repayments become unmanageable? Or is there even a limit?

For instance, if needed, can they raise interest rates to 5%, 10%, 1980's eque 15%? And how long can they keep them at these levels? Is this even calculable/knowable in advance?
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ValuationsMatter
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Re: How high, and for how long, can the Fed raise interest rates?

Post by ValuationsMatter »

I'll throw something out there as fodder to be corrected: a podcaster I've listened to suggested that there's a 1.5x rate rule of thumb. That is, in order to turn inflation around, the fed should hike rates to 1.5 times current inflation. If that's to be believed, then the Fed should already be at ~ 10.5%. Failure to do so, he suggests, won't get inflation under control.

I'm personally not sure that's the right course of action, though. It seems to me that this heightened inflation is not due to a drop from the previous sub-3% rates, but from the expansion of the balance sheet, as well as the supply issues from grinding economies to halts. Therefore, reeling in the balance sheets by nearly as massively as they expanded them may be in order.

I digress. I'm sure there are far more intelligent opinions on this subject than mine.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by 000 »

There is no limit to what they can do. If interest payments on government debt become a problem, they could do a debt jubilee or the government could simply unilaterally adjust the terms of the bonds. That is a real and unique risk of sovereign bonds. They are not a risk free instrument.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by ivgrivchuck »

Phyneas wrote: Sat Jan 22, 2022 11:34 pm If inflation persists at these levels for longer than they'd like, or continues to rise, and the planned interest rate hikes are, or at that point, will have been, ineffective in tamping it down, how much headroom does the Fed have to raise interest rates before the debt repayments become unmanageable? Or is there even a limit?

For instance, if needed, can they raise interest rates to 5%, 10%, 1980's eque 15%? And how long can they keep them at these levels? Is this even calculable/knowable in advance?
They can't raise it to the point where it would break the economy (mass defaults, banking sector collapse). Where exactly that point is, who knows... Considering the huge amount of debt that companies, government, individuals have taken, I suspect that the breaking point can't be much higher than 5%. It might even be significantly lower, who knows...

And if they need to choose between breaking the economy and letting the inflation run, they'll choose the latter...
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HomerJ
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Re: How high, and for how long, can the Fed raise interest rates?

Post by HomerJ »

Phyneas wrote: Sat Jan 22, 2022 11:34 pm If inflation persists at these levels for longer than they'd like, or continues to rise, and the planned interest rate hikes are, or at that point, will have been, ineffective in tamping it down, how much headroom does the Fed have to raise interest rates before the debt repayments become unmanageable? Or is there even a limit?

For instance, if needed, can they raise interest rates to 5%, 10%, 1980's eque 15%?
Sure, if inflation persists, they can raise interest rates as high as they need to.

If inflation persists higher than interest rates, then debt repayments won't become unmanageable.
And how long can they keep them at these levels?
No idea
Is this even calculable/knowable in advance?
No, of course not. No one can predict the future accurately.
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peskypesky
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Re: How high, and for how long, can the Fed raise interest rates?

Post by peskypesky »

I have watched many videos of financial experts discussing this issue and the Fed does seem to be backed into a corner with no good option. To tame inflation, the interest rates would have to be raised to a level that would break the economy and make servicing the national debt impossible.

So...they can't really do that, can they?

Which means, they kind of have to at least make it appear that they are trying to tame inflation...so they will raise rates a bit...but probably not anywhere near what they would need to. The national debt is a beast. The debt spiral is real threat.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by Whakamole »

000 wrote: Sat Jan 22, 2022 11:45 pm There is no limit to what they can do. If interest payments on government debt become a problem, they could do a debt jubilee or the government could simply unilaterally adjust the terms of the bonds. That is a real and unique risk of sovereign bonds. They are not a risk free instrument.
They are risk-free until the debt is so high that they aren't.

The idea that the government can just print money to "pay the debt" has some slight disadvantages.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by ClassII »

peskypesky wrote: Sun Jan 23, 2022 12:58 am I have watched many videos of financial experts discussing this issue and the Fed does seem to be backed into a corner with no good option. To tame inflation, the interest rates would have to be raised to a level that would break the economy and make servicing the national debt impossible.

So...they can't really do that, can they?

Which means, they kind of have to at least make it appear that they are trying to tame inflation...so they will raise rates a bit...but probably not anywhere near what they would need to. The national debt is a beast. The debt spiral is real threat.
I think corporate and private debt are a far bigger concern than the government. A lot of the government's debts are held in very long term instruments and at incredibly low fixed rates to boot. However if they crank rates up that'll cause a lot of businesses and consumers to go belly up as their relatively short, variable interest debt would balloon a la mortgages 2007. Corporate America has been on a debt buying spree the last several years. It was basically free money back then, but now if the Fed starts to increase rates that'll make refinancing said debt extremely expensive. We'll be like Japan with a sea of "zombie corporations" that are doing ok but have such an enormous debt pile can only cover interest payments as long as rates stay super low.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by Phyneas »

HomerJ wrote: Sun Jan 23, 2022 12:05 am
Phyneas wrote: Sat Jan 22, 2022 11:34 pm If inflation persists at these levels for longer than they'd like, or continues to rise, and the planned interest rate hikes are, or at that point, will have been, ineffective in tamping it down, how much headroom does the Fed have to raise interest rates before the debt repayments become unmanageable? Or is there even a limit?

For instance, if needed, can they raise interest rates to 5%, 10%, 1980's eque 15%?
Sure, if inflation persists, they can raise interest rates as high as they need to.

If inflation persists higher than interest rates, then debt repayments won't become unmanageable.
And how long can they keep them at these levels?
No idea
Is this even calculable/knowable in advance?
No, of course not. No one can predict the future accurately.
Does the domestic real estate market have any effect on this? If interest rates shoot through the roof and people are already finding it difficult to afford housing, the combination of high interest rates + high prices could cause severe disruption to the RE market?
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Re: How high, and for how long, can the Fed raise interest rates?

Post by Metsfan91 »

Phyneas wrote: Sat Jan 22, 2022 11:34 pm
For instance, if needed, can they raise interest rates to 5%, 10%, 1980's eque 15%? --Yes, believe so. Haven't come across anything that says fed could not go over 11.93%

And how long can they keep them at these levels? -- Indefinitely
Is this even calculable/knowable in advance? -- Do not think so. Maybe yes, if you can get majority of fed reserve board members to tell you in advance.
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ClassII
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Re: How high, and for how long, can the Fed raise interest rates?

Post by ClassII »

Phyneas wrote: Sun Jan 23, 2022 2:03 amDoes the domestic real estate market have any effect on this? If interest rates shoot through the roof and people are already finding it difficult to afford housing, the combination of high interest rates + high prices could cause severe disruption to the RE market?
I doubt it'll cause a 2008 collapse as Adjustable Rate Mortgages are out of fashion (along with predatory lending) but higher interest on mortgages is going to cause lower prices. Remember, nobody buys a house thinking about its sale price. What they really look at is affording the monthly mortgage payment. That payment, broken down as Principal+Interest+Taxes+Insurance can be split up any which way but the total is what's important. you increase Interest something has to give, and it's probably not Taxes or Insurance.

Again, because most mortgages now are fixed, people won't suddenly not afford to stay in their own homes anymore. However, people looking to buy are going to find their budget won't go as far as it used to. In aggregate this should cause prices to drop accordingly, just like they bounce up when rates go down.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by CraigTester »

Fed chairman Ben Bernanke sat before the Joint Economic Committee, which asked him point blank about inflating away debt. His answer gets to the heart of the matter: "Given the structure of our debt, [inflation] wouldn't even help reduce the debt ... given that so many of our obligations are indexed."

The above quote is a troubling truth.

So whether the Fed sets rates above the inflation rate or not, Uncle Sam is still on the hook for servicing debt adjusted for inflation.

Think I-bonds or SS obligations. Despite market rates currently being less than inflation, the government still pays the inflation adjusted rate, anyway.

So the only “advantage” to holding rates lower than inflation is to temporarily stimulate the economy.

But inflation is demonstrating why this is a temporary measure. E.g. lower rates stimulated housing market until house prices rose to offset. And now young people can’t afford housing so they demand higher wages…and the spiral starts spinning faster….

Unfortunately, because the policy was left in place too long (IMHO) it’s effectively just “recalibrated” everything to this new scale.

So the only way to reduce inflation is to restore the historical relationship where market rates = nominal + inflation.

And as we watched with Paul Volker, the last time we got in this trap, there is no ceiling.

So if the political will exists to slow the price of say meat or gas, rates will need to increase substantially…

And as this happens, relationships between higher market rates and risk-assets like house and stock prices will “recalibrate” to accommodate.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by Phyneas »

CraigTester wrote: Sun Jan 23, 2022 4:23 am Fed chairman Ben Bernanke sat before the Joint Economic Committee, which asked him point blank about inflating away debt. His answer gets to the heart of the matter: "Given the structure of our debt, [inflation] wouldn't even help reduce the debt ... given that so many of our obligations are indexed."

The above quote is a troubling truth.

So whether the Fed sets rates above the inflation rate or not, Uncle Sam is still on the hook for servicing debt adjusted for inflation.

Think I-bonds or SS obligations. Despite market rates currently being less than inflation, the government still pays the inflation adjusted rate, anyway.

So the only “advantage” to holding rates lower than inflation is to temporarily stimulate the economy.

But inflation is demonstrating why this is a temporary measure. E.g. lower rates stimulated housing market until house prices rose to offset. And now young people can’t afford housing so they demand higher wages…and the spiral starts spinning faster….

Unfortunately, because the policy was left in place too long (IMHO) it’s effectively just “recalibrated” everything to this new scale.

So the only way to reduce inflation is to restore the historical relationship where market rates = nominal + inflation.

And as we watched with Paul Volker, the last time we got in this trap, there is no ceiling.

So if the political will exists to slow the price of say meat or gas, rates will need to increase substantially…

And as this happens, relationships between higher market rates and risk-assets like house and stock prices will “recalibrate” to accommodate.
Thank you for the terrific, albeit troubling, answer. How high do interest rates have to go in order to curb inflation do you think? ValuationsMatter suggested interest rates should be 1.5x the inflation rate.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by JoeRetire »

Phyneas wrote: Sat Jan 22, 2022 11:34 pm For instance, if needed, can they raise interest rates to 5%, 10%, 1980's eque 15%? And how long can they keep them at these levels? Is this even calculable/knowable in advance?
They could raise the rates to any level they choose. (hint: they won't approach those wild levels.)

Remember, inflation control is not the only mandate for the Fed. They have other simultaneous concerns.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by 3CT_Paddler »

CraigTester wrote: Sun Jan 23, 2022 4:23 am Fed chairman Ben Bernanke sat before the Joint Economic Committee, which asked him point blank about inflating away debt. His answer gets to the heart of the matter: "Given the structure of our debt, [inflation] wouldn't even help reduce the debt ... given that so many of our obligations are indexed."

The above quote is a troubling truth.

So whether the Fed sets rates above the inflation rate or not, Uncle Sam is still on the hook for servicing debt adjusted for inflation.

Think I-bonds or SS obligations. Despite market rates currently being less than inflation, the government still pays the inflation adjusted rate, anyway.

So the only “advantage” to holding rates lower than inflation is to temporarily stimulate the economy.

But inflation is demonstrating why this is a temporary measure. E.g. lower rates stimulated housing market until house prices rose to offset. And now young people can’t afford housing so they demand higher wages…and the spiral starts spinning faster….

Unfortunately, because the policy was left in place too long (IMHO) it’s effectively just “recalibrated” everything to this new scale.

So the only way to reduce inflation is to restore the historical relationship where market rates = nominal + inflation.

And as we watched with Paul Volker, the last time we got in this trap, there is no ceiling.

So if the political will exists to slow the price of say meat or gas, rates will need to increase substantially…

And as this happens, relationships between higher market rates and risk-assets like house and stock prices will “recalibrate” to accommodate.
The government could also just as easily remove the inflation indexing of SS and stop selling TIPS and IBonds.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by JoeRetire »

3CT_Paddler wrote: Sun Jan 23, 2022 6:26 am The government could also just as easily remove the inflation indexing of SS.
Easily? "The government" is comprised of politicians who usually want to get re-elected, right?

There's nothing "easy" about sticking it to grandma.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by JDave »

They went to 17% in my lifetime. I assume they can do it again.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by vtsnowdin »

While I think the Fed can and probably will raise rates sharply I do not think they can hold them there for very long but perhaps a year or two. Consider that the current National debt is about to top 30 Trillion and last years tax receipts just topped 4 trillion.
So If they raise rates to say 10 percent and held it there long enough to let the average of all the T bonds outstanding rise to 5% The interest bill would rise to 1.5 Trillion per year. Congress would have to raise taxes by 1.5 Trillion or cut spending by 1.5 trillion both very unpopular and quite unlikely.
I expect that over time leaders will seek better alternatives like making moves to increase domestic energy production to lower energy prices along with all the things produced using energy which is everything from food to smart phones.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by frugalecon »

Unless the Fed starts raising rates by 50 bps per meeting, it will take two years to even get to the 2-2.5% level on short-term interest rates, which is what they control. The roll off of stimulative fiscal policy might have a bigger impact on inflation dynamics in that timeframe. The experience of the last two years suggests to me that fiscal policy has a bigger impact on inflation than monetary policy.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by JoMoney »

Just want to point out the Fed had recently changed its inflation targeting to a more flexible "average inflation targeting". While the past years 7% inflation is pretty shocking, I think it's worth pointing out that over the past decade it's still at a 2% average/CAGR.... but of course we don't know what formula or time period the fed might use for their target "average" either.
https://www.federalreserve.gov/newseven ... 00827a.htm
...our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting. Our decisions about appropriate monetary policy will continue to reflect a broad array of considerations and will not be dictated by any formula...
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Re: How high, and for how long, can the Fed raise interest rates?

Post by CraigTester »

Phyneas wrote: Sun Jan 23, 2022 6:04 am
CraigTester wrote: Sun Jan 23, 2022 4:23 am Fed chairman Ben Bernanke sat before the Joint Economic Committee, which asked him point blank about inflating away debt. His answer gets to the heart of the matter: "Given the structure of our debt, [inflation] wouldn't even help reduce the debt ... given that so many of our obligations are indexed."

The above quote is a troubling truth.

So whether the Fed sets rates above the inflation rate or not, Uncle Sam is still on the hook for servicing debt adjusted for inflation.

Think I-bonds or SS obligations. Despite market rates currently being less than inflation, the government still pays the inflation adjusted rate, anyway.

So the only “advantage” to holding rates lower than inflation is to temporarily stimulate the economy.

But inflation is demonstrating why this is a temporary measure. E.g. lower rates stimulated housing market until house prices rose to offset. And now young people can’t afford housing so they demand higher wages…and the spiral starts spinning faster….

Unfortunately, because the policy was left in place too long (IMHO) it’s effectively just “recalibrated” everything to this new scale.

So the only way to reduce inflation is to restore the historical relationship where market rates = nominal + inflation.

And as we watched with Paul Volker, the last time we got in this trap, there is no ceiling.

So if the political will exists to slow the price of say meat or gas, rates will need to increase substantially…

And as this happens, relationships between higher market rates and risk-assets like house and stock prices will “recalibrate” to accommodate.
Thank you for the terrific, albeit troubling, answer. How high do interest rates have to go in order to curb inflation do you think? ValuationsMatter suggested interest rates should be 1.5x the inflation rate.
Superficially its an easy answer....which is "anything higher than the prevailing inflation rate"... E.g. The bigger the spread above inflation, the bigger the impact....

But practically speaking, its much more complicated....

First, there are obstacles around agreeing on what the "prevailing inflation rate" is....e.g. comparing spreads between tips and nominals suggests the bond market is "expecting" fairly subdued inflation .... However, if you think a little deeper, perhaps the bond market is just expressing its opinion of what they "expect" the fed to do about it.....

And this brings us to the bigger obstacle that persisted for a long time before Paul Volker finally delivered the necessary medicine, last time ..... Its in a lot of people's best interest to pretend inflation is not a problem.....And even if it gets acknowledged as a problem, they assign its "cause" is mostly rooted in "supply chain disruptions"... And the problem with this thinking, is that it is "partially" correct.....But blaming "most" of inflation on supply chains, just provides too much excuse for the fed to continue to delay necessary action.... (This is remarkably similar to the environment that Volker faced)

And even though we no longer hear the word "transitory", it will be really interesting to see what actions the Fed will actually implement.....They are saying the right things, right now....But given that valuation levels remain very high, their words are still being heavily "discounted"....

So my real answer to your question is that it can't be answered until we can predict how long this "limbo" phase will be allowed to persist.... The longer we stay in limbo, the higher rates will ultimately need to get to address the problem....
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Re: How high, and for how long, can the Fed raise interest rates?

Post by HomerJ »

peskypesky wrote: Sun Jan 23, 2022 12:58 am I have watched many videos of financial experts discussing this issue and the Fed does seem to be backed into a corner with no good option. To tame inflation, the interest rates would have to be raised to a level that would break the economy and make servicing the national debt impossible.
No, because as long as inflation is higher than the Treasury Bill (i.e. very short-term) interest rates, debt is technically getting easier to service because it's getting inflated away.

As soon as inflation goes down, they can start reducing the interest rates as well.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by KlangFool »

Phyneas wrote: Sat Jan 22, 2022 11:34 pm If inflation persists at these levels for longer than they'd like, or continues to rise, and the planned interest rate hikes are, or at that point, will have been, ineffective in tamping it down, how much headroom does the Fed have to raise interest rates before the debt repayments become unmanageable? Or is there even a limit?

For instance, if needed, can they raise interest rates to 5%, 10%, 1980's eque 15%? And how long can they keep them at these levels? Is this even calculable/knowable in advance?
Phyneas,

I don't know and I don't care. I am prepared.

As to why you should care, please explain that to us.

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Re: How high, and for how long, can the Fed raise interest rates?

Post by peskypesky »

HomerJ wrote: Sun Jan 23, 2022 3:44 pm
peskypesky wrote: Sun Jan 23, 2022 12:58 am I have watched many videos of financial experts discussing this issue and the Fed does seem to be backed into a corner with no good option. To tame inflation, the interest rates would have to be raised to a level that would break the economy and make servicing the national debt impossible.
No, because as long as inflation is higher than the Treasury Bill (i.e. very short-term) interest rates, debt is technically getting easier to service because it's getting inflated away.

As soon as inflation goes down, they can start reducing the interest rates as well.
they have to raise the rates to get inflation to go down.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by alex_686 »

I would start by reading up on the Taylor Rule.

https://en.m.wikipedia.org/wiki/Taylor_rule

The Fed can pick any rate. Any rate they pick will have a lag of about 18 months before the impact shows up in the real economy.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by quattro73 »

They need to go ahead and raise the Fed Funds rate by 50bps and see how much cold water that throws on things and what the long end of the curve reaction is. Just get it done.
We are far more sensitive to things than we used to be or sure seems that way.
There is still a considerable amount of this inflation driven by shutdown related disruptions to supply chains, in my opinion only. Get some cooling off of demand, and let those things sort themselves and hopefully we can get closer to “normal”.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by DeliberateDonkey »

peskypesky wrote: Sun Jan 23, 2022 3:48 pm
HomerJ wrote: Sun Jan 23, 2022 3:44 pm
peskypesky wrote: Sun Jan 23, 2022 12:58 am I have watched many videos of financial experts discussing this issue and the Fed does seem to be backed into a corner with no good option. To tame inflation, the interest rates would have to be raised to a level that would break the economy and make servicing the national debt impossible.
No, because as long as inflation is higher than the Treasury Bill (i.e. very short-term) interest rates, debt is technically getting easier to service because it's getting inflated away.

As soon as inflation goes down, they can start reducing the interest rates as well.
they have to raise the rates to get inflation to go down.
While I anticipate that they will follow through with the planned rate hikes, it is difficult to argue that the recent spike in inflation was driven purely by interest rates and/or quantitative easing. As those other factors fade, so too will inflation, regardless of what the Fed does.

People love to talk about the price of gas, but conveniently ignore that the price at the pump was higher ten years ago than it is today, even despite higher gas taxes in many states. There are still plenty of deflationary forces at work in the world, only temporarily disrupted.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by Nathan Drake »

JoMoney wrote: Sun Jan 23, 2022 7:05 am Just want to point out the Fed had recently changed its inflation targeting to a more flexible "average inflation targeting". While the past years 7% inflation is pretty shocking, I think it's worth pointing out that over the past decade it's still at a 2% average/CAGR.... but of course we don't know what formula or time period the fed might use for their target "average" either.
https://www.federalreserve.gov/newseven ... 00827a.htm
...our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting. Our decisions about appropriate monetary policy will continue to reflect a broad array of considerations and will not be dictated by any formula...
Ah yes, the ever-changing methodology and targets of the FED to undermine the serious issue of inflation.
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000
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Re: How high, and for how long, can the Fed raise interest rates?

Post by 000 »

JoeRetire wrote: Sun Jan 23, 2022 6:30 am
3CT_Paddler wrote: Sun Jan 23, 2022 6:26 am The government could also just as easily remove the inflation indexing of SS.
Easily? "The government" is comprised of politicians who usually want to get re-elected, right?

There's nothing "easy" about sticking it to grandma.
You know the government already has stuck it to grandma by making social security partly taxable?

What's to stop them from making it fully taxable and raising tax rates? Not a single thing.... especially if both "teams" support it.
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Re: How high, and for how long, can the Fed raise interest rates?

Post by Flyer24 »

Topic has derailed into an economic policy discussion by the government which is off-topic for investment. Thread is locked.


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- US or world economic, political, tax, health care and climate policies
- conspiracy theories of any type
- discussions of the crimes, shortcomings or stupidity of other people, whether they be political figures, celebrities, CEOs, Fed chairmen, subprime mortgage borrowers, lottery winners, federal "bailout" recipients, poor people, rich people, etc. Of course, you are welcome to talk about the stupid financial things you have done.
Locked