The Federal Reserve Likes to Keep Inflation at 2%. But Will We Ever Get Back There?

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The answer? Possibly…but not anytime soon. 

It’s hardly a secret that inflation has been battering consumers for well over a year. And in 2022, many people had to resort to measures like racking up credit card debt and raiding their savings just to cover their higher living costs.

The Federal Reserve, meanwhile, isn’t happy about inflation. That’s why it’s been so aggressive with its interest rate hikes.

The Fed raised interest rates seven times in 2022. And it’s not done doing so, either. In fact, in late 2022, Federal Reserve Chair Jerome Powell was quoted as saying, “For wage growth to be sustainable, it needs to be consistent with 2% inflation.”

Of course, 2% inflation would be nice. But that’s not at all where we’re at. And while we might get there eventually, consumers should not expect inflation to fall to that degree within the next 12 months. That means we may need to brace for continued rate hikes — and higher borrowing costs to go along with them.

Inflation levels are shrinking, but not quickly enough

In December of 2022, the Consumer Price Index (CPI), which measures changes in the cost of consumer goods, rose 6.5% on an annual basis. That’s a far cry from the 2% level the Federal Reserve is looking for.

Of course, December’s CPI reading is far better than June’s. At that point, inflation rose at 9.1% on an annual basis, representing a peak.

But still, the Fed is unlikely to be satisfied with 6.5% inflation, given that it wants to get the economy back down to 2%. And that means that consumers may be in for a series of interest rate hikes in 2023, despite cooling inflation.

Now that said, those rate hikes may be less substantial individually than they were in 2022. Last year, the Fed implemented several 0.75% rate hikes. This year, the Fed might settle on 0.25% increases.

But still, borrowing costs are already up, especially on mortgages. And if rate hikes continue, consumers might struggle to borrow even more in 2023 — to the point where they have to cut back on spending and potentially drive us closer to a recession.

Is 2% inflation attainable?

Absolutely. It’s a rate we’ve seen many times before and are likely to see again. But we need to be reasonable in our expectations.

We’re unlikely to go from 6.5% inflation to 2% inflation in the course of a year, even with rate hikes in the mix. So a more reasonable bet may be to hope for 4% to 5% inflation later on in 2023.

To be clear, that would still spell a lot of relief for consumers compared to 2022. So if we get there within the next 12 months, that’s something to celebrate — even if the Fed doesn’t think so.

Meanwhile, until inflation levels drop even more, consumers should aim to be very careful about borrowing. Signing a loan or racking up a credit card balance now might mean paying a lot more interest than expected. And at a time when living costs are still up, dangerously high loan payments have the potential to wreak utter havoc.

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