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Why the Fed’s latest interest rate hike is controversial

Will the Fed push the economy into a recession? Some experts worry rates have risen too fast.

Markets Open As Traders Await News From Federal Reserve
Traders work on the floor of the New York Stock Exchange on May 3, 2023 in New York City.
Spencer Platt/Getty Images
Li Zhou is a politics reporter at Vox, where she covers Congress and elections. Previously, she was a tech policy reporter at Politico and an editorial fellow at the Atlantic.

On Wednesday, the Federal Reserve raised interest rates another quarter point in regulators’ ongoing bid to reduce inflation. It’s a move that marks the Fed’s 10th straight rate hike and it’s one that’s proven contentious given fears that it could slow the economy too much.

The rate hike — which puts the Fed’s benchmark rate between 5 to 5.25 percent — comes as another mid-size bank, First Republic Bank, failed and was later acquired by JPMorgan Chase, becoming the second-largest bank failure in US history. The Fed favors the hike because it’s continuing to fight inflation, which has dipped substantially in the last year. At 5 percent, inflation is still higher than the Fed’s target rate of 2 percent.

Economists and experts who oppose raising rates, however, say inflation is already showing signs of slowing, and that additional rate increases could add even more challenges for small businesses and lead to a harmful uptick in unemployment.

Ultimately, the concern is that another quarter-point rate hike could contribute to a recession that many have been dreading for months. On Monday, a group of Democrats including Sen. Elizabeth Warren and Rep. Pramila Jayapal were among those who urged a pause on the Fed’s hikes, in order to “avoid engineering a recession that destroys jobs and crushes small businesses.”

“The arguments in favor of another rate hike … rest on the concern that inflation will remain persistently too high,” Moody’s chief economist Mark Zandi told Vox. “My view is that … any further rate hikes increases the odds that the Fed will unnecessarily push the economy into recession.”

Federal Reserve chair Jerome Powell defended the move in a briefing on Wednesday, noting the need to “balance the risk of not doing enough and not getting inflation under control against the risk of maybe slowing down economic activity too much.”

The arguments in favor of the hike, briefly explained

In the last year, the Fed has been laser-focused on a central goal: bringing inflation down.

As Vox’s Emily Stewart explained, its main tool for doing that has been raising interest rates, which makes borrowing money more expensive for consumers and businesses. The thinking behind this approach is that as borrowing goes down, consumer spending and demand also decline, leading to reductions in price.

The Fed’s decision to hike interest rates again is simply a continuation of this approach, and many economists and market watchers theorize that this could be the last hike for the next few months. “​​We are taking the only measures we have to bring inflation down,” Powell testified in Congress earlier this year. Comments he made Wednesday also signaled that the Fed would likely be more conservative about additional rate increases, though he didn’t take them off the table completely.

Inflation has decreased significantly — it was at a high of 9 percent in June of last year. At the same time, however, core inflation, which does not include the more volatile prices of food and energy, saw an uptick in March to 5.6 percent from 5.5 percent in February. These increases are being driven by the rising cost of services like transportation, child care, and hospitality, per the New York Times, and they could indicate that inflation is still a problem. There’s also been increasing scrutiny on corporations for raising prices and padding profits.

The argument for another hike is that “the Fed needs to raise interest rates more to weaken the economy to sufficiently quell the still intense wage and price pressures,” says Zandi.

The arguments against the hike, briefly explained

As the Fed’s hikes have continued, there’s also been growing opposition to them due to fears that they could fuel another recession and have other negative side effects.

As the failure of multiple banks — including Silicon Valley Bank, Signature Bank, and First Republic Bank — have shown, higher interest rates have meant that the Fed’s rate hikes can have unexpected ripple effects.

“The Fed has already broken something. It is going to break more things if it keeps hiking,” says Stony Brook economist Stephanie Kelton. Given the recent bank failures, other financial institutions are poised to limit the lending they do, a move that could impact small businesses and their ability to get loans.

Additionally, it takes time for the impact of rising interest rates to wind through the economy, another reason some economists have cautioned the Fed against doing more now. The reduced lending by banks after the recent round of bank failures could serve as a means of cooling the economy, a move that could effectively have the same effect as another rate hike.

“Right now there’s ongoing problems in the banking industry, and while it looks contained, there’s likely to be a decrease in lending, especially to small and medium businesses that rely on mid-sized regional lenders. That’s going to slow the economy in ways we don’t appreciate yet, and could cause a recession on its own,” says Mike Konczal, the director of macroeconomic analysis at the Roosevelt Institute.

There are concerns that interest rate hikes, by reducing spending, could also increase unemployment. Currently, the overall unemployment rate is 3.5 percent, near the lowest it’s been in five decades. The Black unemployment rate is also at 5 percent, the lowest it’s ever been.

“Continued interest rate hikes needlessly threatens this progress,” the Democrats including Warren and Jayapal wrote in their letter to the Fed. “The evidence to date suggests that progress can continue to be made without slamming the brakes on the economy and costing millions of Americans their jobs.” Some lawmakers argue that another interest rate increase would cool the labor market to the point that 2 million people could lose their jobs, a development that would heavily affect low-wage workers.

An April survey from WalletHub found that seven of 10 consumers said they’d dealt with higher expenses related to these rate hikes, which can include higher costs for mortgages and credit card payments. Those opposed to the Fed’s actions argue that regulators should take more time to see how existing interest rate increases and changes in bank behavior affect the economy.

Update, May 3, 4 pm ET: This story was originally published on May 3 and has been updated to include Fed chair Jerome Powell’s comments.