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The time was right for an aggressive rate hike, former Fed economist says

RACHEL MARTIN, HOST:

Oh, to be a member of the Fed right now. The Federal Reserve is in this delicate dance to try and rein in inflation without sinking the economy. But it has decided to make a big move. The Fed has announced it's raising interest rates three-quarters of a percentage. This is the highest increase in almost three decades. Claudia Sahm is a former Federal Reserve economist, and she joins us this morning. Hi, Claudia.

CLAUDIA SAHM: Good morning.

MARTIN: We know the Fed tends to act with caution in general. Why such an aggressive move now?

SAHM: Right, well, when the moment requires it, the Federal Reserve will act swiftly. And this is a moment. It's not a surprise to anyone. Inflation is high. The Fed's job is to get it under control, and it wants to do it before people start losing their jobs. So now is the time, and that's what they're doing.

MARTIN: I mean, when we talk about interest rates, we're talking about the money it costs to borrow money. So explain how people are going to feel the effects of this most acutely.

SAHM: Right. Well, as you said, this is the tool the Fed has. It's the only one. And frankly, what interest rates are is it's a price. It's making it more costly to borrow take out a loan to buy a car, to buy a house, your credit card, to buy something. To get inflation under control, the Fed's tool is to just calm it down a notch. Like, put off some of these purchases. Save a little bit of money, a little bit more, and if we can do that, that is one way to bring inflation down. It's not - I mean, frankly, it's not a nice way - right? - because we have to put off the things that we need or we want right now, but we want inflation down. Like, that is absolutely clear that it is a problem for millions and millions of people.

MARTIN: I want to ask about mortgages for a moment because we've seen a real slowdown in the home market. It's becoming more and more expensive to achieve that part of the American dream. But 30-year mortgages aren't directly linked to the Fed's short-term rate, right? Can you walk us through that and explain how this is going to affect people who are looking for those mortgages?

SAHM: Right. Well, the Federal Reserve, it has a policy interest rate, the federal funds rate. It's really low even when they raise it, but none of us can borrow at that low rate. But as soon as the Federal Reserve starts raising their interest rate, interest rates throughout financial markets start to rise. Now, there's a lot of other reasons that push interest rates up and down. The Fed, it's one of those, and it has a pretty strong lever. And so we've seen even before the Fed raises interest rates - when they just tell us, hey, it's coming, interest rates - and mortgage rates in particular - they have gone up more than the federal funds policy rate. And that is part of the idea, is to - people to hold off buying homes. And we're already seeing that in the data. But, like, that's just one thing that people buy, right? So we need to see it more broadly but not abruptly.

MARTIN: So inflation is up, but unemployment is really low, right? Workers have a lot of options right now. Will raising interest rates have any bearing on that?

SAHM: Well, as you said, we're halfway through this recovery. It's a big win that people are back to jobs. People have got - you know, many have gotten raises, moved to better jobs. That's great. Part of the Fed's mandate is maximum employment, right? We can - we made a lot of progress there. The other part is price stability. We are not there, right? This is a recovery incomplete. Now the Fed is trying to bring inflation down without people losing jobs. It's really tough. They don't have a lot of record on this, but they're absolutely committed, and I think they are on a path to do it.

MARTIN: OK. So this is all a delicate, you know, balancing act that the Fed has to navigate. But, Claudia, when are they going to figure out when inflation is back at an appropriate level?

SAHM: Fed Chair Jay Powell said recently that they're looking for inflation to come down in a clear and convincing way. So that's not one month of data or two months of data. They really want to see it moving down. What the Fed has said for a long time they feel like is a good place for inflation to be is at 2%. We are way away from 2%. So that's what they're looking for, but they're keeping an eye on everything going on in the economy and in particular on jobs. But inflation is the focus right now, and it really needs to come down in a way that we can say, it's going down. We're getting there.

MARTIN: Claudia Sahm is a former Fed economist. She's now a senior fellow at the Jain Family Institute. We appreciate your time this morning and perspective, Claudia. Thank you.

SAHM: Thank you. Transcript provided by NPR, Copyright NPR.