By Perc Pineda, Ph.D.
Chief Economist, PLASTICS

The Federal Reserve raised the economy’s benchmark interest rate by 50 basis points (bps) at the Federal Open Market Committee’s final meeting in December of this year. The move takes the federal funds rate to a 4.25% to 4.50% target range, which means the U.S. prime rate is now 7.5%.

In theory, with higher rates, interest-rate-sensitive end markets for plastics will continue to see a moderation in business activities. Additionally, capital expenditures could slow as businesses evaluate the cost of capital vis-à-vis expected inflation-adjusted returns, given more moderate rates of economic growth.

Inflation and economic growth

While the inflation rate in October, measured by the year-on-year change in the Consumer Price Index, decreased from the previous months, it remains well above an inflation rate that can sustain maximum economic growth. The Federal Reserve’s longer-run inflation target is 2.0%, but the Personal Consumption Expenditure Price Index, which is the Fed’s preferred measure of inflation when conducting monetary policy, rose 6.0% in October.

Against the backdrop of persistent inflation rates—above the 2.0% target—the economy’s labor market remains resilient. Given the Federal Reserve’s mandate of maintaining price stability and full employment, data suggests that additional rate hikes are forthcoming to address the former. At the same time, the 450-bps increase to the federal funds rate this year has not negatively affected the economy’s labor market thus far.

Estimating the pace of policy effects

Monetary policy has lags, and yet it is difficult to predict lag lengths given that initial conditions matter when policy changes occur. The Federal Reserve started tightening monetary policy with a 25-bps rate hike in March this year when aggregate demand was pulling significantly faster than aggregate supply. Nine months later, the economy continues to experience inflationary pressures which continue to constrict the consumer’s budget.

This means that the Federal Reserve will continue to raise rates to bring down inflation. For this to happen, the economy’s aggregate demand must slow without shortages of goods and services. Aggregate supply has not kept pace with aggregate demand given the cumulative effects of supply chain bottlenecks both during and following the COVID-19 pandemic.

The Federal Reserve’s projections of real economic growth this year and next is 0.5% and the appropriate level of the fed funds rate is to reach 5.1% by the end of next year. At these rates, the Federal Reserve expects the 2023 unemployment rate at 4.6%, and the 2023 inflation rate to be at 3.1%.