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How Do Higher Interest Rates Bring Down Inflation?

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This kind of communication was less common 30 years ago. But a series of Fed chairs — Alan Greenspan, Ben S. Bernanke and Janet L. Yellen — expanded the practice. Jerome H. Powell, confirmed for his second term as the leader of the Fed on Thursday, has made it central. The Fed uses official statements, publicly disseminated economic projections, speeches, interviews and news conferences to tell the markets where it wants them to be heading.At this moment, Professor Phelps said, the Fed may be “scaring people in financial markets into believing that they should lower their expectations of inflation.”He added, “The Fed is saying we should believe the inflation rate is going to fall as a result of the Fed’s efforts.” The idea is that “the markets are already expecting that the Fed is going to succeed in lowering expectations of inflation, and that will lower inflation itself.”That’s the theory, at least. There’s some evidence that it works. Longer-term interest rates have risen substantially this year, not just as a mechanical response to increases in the Fed funds rate but as a reflection of changing views in the markets of where the Fed wants interest rates and inflation to be a year or two from now.This a …

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