Why the Fed Raised Rates Again

Why the Fed Raised Rates Again

December 24, 2018

The Federal Reserve raised its key interest rate Wednesday for a fourth time this year to combat inflation so they say. The goal of the Federal Reserve is to maintain an inflation rate of around 2% while November the inflation rate came in at 2.18%. The Fed basically uses the Federal Funds to put the brakes on a robust economy or to stimulate a weak economy. So, what is the true inflation rate from 2008 to 2018?

The dollar experienced an average inflation rate of 1.59% per year during this period. In other words, $100 in 2008 is equivalent in purchasing power to $117.06 in 2018, a difference of $17.06 over 10 years. The 2008 inflation rate was 3.84%. The current inflation rate (2017 to 2018) is now 2.18%. What about the inflated stock market? The DOW reached a record high 26,828.39 on Oct 3 this year which is an increase of 205% from Dec 2008.

Though the average inflation rate since 2008 has been very low averaging around 1.59% the stock market though has experienced hyperinflation mainly driven by institutional buying and lately since the new tax law went into effect companies have been buying back their own stock.  Many companies might think it’s in their shareholder's best interest to implement stock buyback programs instead of investing in employees, new equipment or expansion.

The Federal Reserve is really trying to put the brakes on the over-inflated stock market vs actual inflation it would seem. When evaluating the overall health of the economy the things you want to watch are GDP which is 3.4% slightly above ideal while Durable Goods rose .8% in October which is still moderate. While the unemployment rate is a lagging indicator it is not as useful statistic though adding on average 155,000 jobs would still be considered healthy.

Interest rates rising is also a sign of a healthy economy. If interest rates are too low that can create liquidity problems. The stock market correcting after hitting higher highs for a long time then goes into a correction is actually healthy if all other indicators are robust.