<blockquote>
<p>What are the benefits of raising rates slowly? Obviously getting a feel for the economy with as little interjection as possible is good, but why didn't they just raise the rates by say 2 or more whole percentage points at the get go back in March of 2022? Would a large spike in the rate be more beneficial? why or why not?</p>
</blockquote>
<p>There are several reasons.</p>
<ul>
<li><p>Ceteris paribus, in short run hiking interest rates is contractionary. As a result no central bank would be happy overshooting and rising interest rates more than necessary. However, at the same time central banks are not omniscient, and they do not necessarily know what is the correct interest rate that will be consistent with their goals. They can, <a href="https://www.federalreserve.gov/econres.htm" rel="nofollow noreferrer">and do</a>, use various econometric analysis and research that they use in their decision making (including what interest rates to set), but that involves large amount of uncertainty. In such case it makes sense to hike interest rates less than necessary and wait and see what happens.</p>
</li>
<li><p>Although, Fed's mandate is just price stability and promoting full employment, not making households or banks happy, they still need to act cautiously when intervening in the economy. For example, hypothetically if there is large number of adjustable rate mortgages out there, and households are overleveraged, high sudden and unexpected spike in interest rate could force many households to default on their mortgages, and in turn too much defaults could result in banking crisis and recession generally. That would conflict with Fed's goal of maintaining full employment. If the interest rate hike is less sudden households have more time adjusting (e.g. time to figure out where to cut spending or earn more money).</p>
</li>
<li><p>Research clearly shows inflation has high level of persistence (<a href="https://www.sciencedirect.com/science/article/pii/S0165188906000972?casa_token=aFReVYH4CB4AAAAA:ubgQp5lTSx3bUtNTkCmUoxbvvS6PpScVWOhm0n9ox706hYvSXpUEjrWdyDIYo19tonSsMJV8riw" rel="nofollow noreferrer">Pivetta &amp; Reis, 2007)</a>. Hence, any change in interest rate now will take time to have effect. It is <em>technically</em> completely possible that the current hike was sufficient to bring inflation to Fed's desired level and we just don't know it yet. It is also possible, it is not sufficient of course, but here the first two points kick in.</p>
</li>
</ul>
<p>PS:</p>
<p>Even if inflation will be lowered to <a href="https://www.federalreserve.gov/faqs/economy_14400.htm" rel="nofollow noreferrer">Fed's goal of 2%</a>, that does not mean prices will come down. Inflation, is positive increase in prices, so even with 2% inflation prices will be increasing just not as fast as they are doing now.</p>
<p>For prices to decrease there would have to be deflation, and that goes against Fed's objective of keeping inflation at 2%. Hence, unless policy is changed, or economy will be in liquidity trap (situation when monetary policy is ineffective) and there will be deflation due to other factors, Fed will always step in to prevent deflation. So it is extremely unlikely the prices will decline, they will just stop increasing at such high rate.</p>

CC BY-SA 4.0
2023-03-30T13:56:36.073Z
if what u say is right, inflation is persistent, then wouldn't a spike in rate be better strategy? maybe it's persistent b/c they don't spike the rate. as for ARM that's a good point, but there is a cap too.
blue_ego
CC BY-SA 4.0
2023-03-30T14:21:23.523Z
nevermind ARM, existing fixed mortgages are a real headache for the lender.
blue_ego
CC BY-SA 4.0
2023-03-30T16:54:40.343Z
@blue_ego no, because if there is persistence then even if there is high spike, it will take time for the spike to lower inflation and by time inflation is lowered they might discover they lowered it too much. Remember Fed tries to keep inflation around 2% that is their goal. They get criticized/applauded depending on how well they can achieve that while keeping economy stimulated during recession. They don't want inflation to be 1% and they want to avoid deflation at any cost
1muflon1
CC BY-SA 4.0
2023-03-30T18:06:34.050Z
"Only about 10% of total mortgage holders have ARMs. The percentage was only about 5% before 2021. "
blue_ego
CC BY-SA 4.0
2023-03-30T19:12:25.853Z
@blue_ego yes, so? 1. That was just an illustrative example, nowhere I make claim that this is the single most important issue, nor I am even claiming its the most important issue now (mortgages were bigger issue in 2009). However, its an *example* of problems central banks can indirectly worry. Currently the issue is that regulation promoted banks to buy government bonds (as they get zero risk weight) but although the default risk of gov debt might be zero, interest rate risk is high, which is creating massive unrealized losses for banks. But there are other issues with business debt etc
1muflon1
CC BY-SA 4.0
2023-03-30T19:14:07.790Z
2. I also never said this is the sole reason why slow interest r adjustment makes sense. Its one of three main reasons. I did not order the reasons in terms of importance, if I would do so I would say 3 is the most important 1 second and 2 third although they are all quite important
1muflon1
CC BY-SA 4.0
2023-03-29T23:05:07.867Z
2023-03-29T23:05:07.867Z
1muflon1
<p>Search Disinflation vs deflation as to why prices haven't gone down. The rate of inflation has decreased,but past inflation hasn't been corrected. As to why not do it all at once, you'd have a lot more banks crashing if that were to happen. You need to give the market time to adjust.</p>

CC BY-SA 4.0
2023-03-27T14:17:28.557Z
Thanks. Do you have any proof that banks would crash with a sudden jump in rate? model data would work...
blue_ego
CC BY-SA 4.0
2023-03-29T00:14:51.007Z
It's quite simple, we just need to see why they crashed now. A lot of banks keep money in long-term bonds. Let's say I buy one billion dollars worth of 10 years bonds at 1.5% per year. Overnight the fed raises the rates by 3%. Now, the 10 year bonds are at 3.5%. My bonds just went from being worth a billion dollars on the current market to half a billion dollars in the current market. The bank can't pull out, it's too much of a loss. They can't lower interest rates, they need to stay competitive. If you raise the rates slowly, you give the market (and the banks) time to adjust. If not...
Yaya77
CC BY-SA 4.0
2023-03-27T14:06:57.727Z
2023-03-27T14:06:57.727Z
Yaya77
<p>Although the Federal Reserve has been raising interest rates for about 1 year, and inflation has slowed down, prices are not going down much.  What are the benefits of raising rates slowly?  Obviously getting a feel for the economy with as little interjection as possible is good, but why didn't they just raise the rates by say 2 or more whole percentage points at the get go back in March of 2022?   Would a large spike in the rate be more beneficial?  why or why not?</p>
<p>From another answer on this site:
&quot;The longer the time period, the more other factors (inflation [expectations], productivity growth etc) play a role.&quot;</p>
<p>By adjusting the rates slowly, other factors might influence the desired outcome.</p>

CC BY-SA 4.0
2023-03-22T19:56:30.690Z
Going too quickly would crash the economy too hard and possibly cause a crisis that gets out of control, due to linkages throughout the economy. The economy needs to gradually adjust to higher rate, so the FED also needs to gradually adjust. Further, they dont want to rasie rates more than they have to. So they'll see first if a small increase does the trick and only raise more if necessary.
BB King
CC BY-SA 4.0
2023-03-22T20:09:49.067Z
Slowing inflation, if it remains positive, does not imply prices coming down, as you suggest. Also, as far as interest rate hikes go, this has been one of the most aggressive cycles that we have seen in a while.
BrsG
<inflation><interest-rate><fed-funds-rate>
impact of a gradual adjustment of the federal funds rate
blue_ego
# impact of a gradual adjustment of the federal funds rate

(Asked by: username_0 on 2023-03-22)

Although the Federal Reserve has been raising interest rates for about 1 year, and inflation has slowed down, prices are not going down much. What are the benefits of raising rates slowly? Obviously getting a feel for the economy with as little interjection as possible is good, but why didn't they just raise the rates by say 2 or more whole percentage points at the get go back in March of 2022? Would a large spike in the rate be more beneficial? why or why not?

From another answer on this site:
"The longer the time period, the more other factors (inflation [expectations], productivity growth etc) play a role."

By adjusting the rates slowly, other factors might influence the desired outcome.

**Tags:** inflation, interest-rate, fed-funds-rate

> **Comments:**
> **username_1**: Going too quickly would crash the economy too hard and possibly cause a crisis that gets out of control, due to linkages throughout the economy. The economy needs to gradually adjust to higher rate, so the FED also needs to gradually adjust. Further, they dont want to rasie rates more than they have to. So they'll see first if a small increase does the trick and only raise more if necessary.  
> **username_2**: Slowing inflation, if it remains positive, does not imply prices coming down, as you suggest. Also, as far as interest rate hikes go, this has been one of the most aggressive cycles that we have seen in a while.  

---

## 2 answers

### Answer by username_3 on 2023-03-29. Score: 2

> What are the benefits of raising rates slowly? Obviously getting a feel for the economy with as little interjection as possible is good, but why didn't they just raise the rates by say 2 or more whole percentage points at the get go back in March of 2022? Would a large spike in the rate be more beneficial? why or why not?

There are several reasons.

* Ceteris paribus, in short run hiking interest rates is contractionary. As a result no central bank would be happy overshooting and rising interest rates more than necessary. However, at the same time central banks are not omniscient, and they do not necessarily know what is the correct interest rate that will be consistent with their goals. They can, [and do](https://www.federalreserve.gov/econres.htm), use various econometric analysis and research that they use in their decision making (including what interest rates to set), but that involves large amount of uncertainty. In such case it makes sense to hike interest rates less than necessary and wait and see what happens.
* Although, Fed's mandate is just price stability and promoting full employment, not making households or banks happy, they still need to act cautiously when intervening in the economy. For example, hypothetically if there is large number of adjustable rate mortgages out there, and households are overleveraged, high sudden and unexpected spike in interest rate could force many households to default on their mortgages, and in turn too much defaults could result in banking crisis and recession generally. That would conflict with Fed's goal of maintaining full employment. If the interest rate hike is less sudden households have more time adjusting (e.g. time to figure out where to cut spending or earn more money).
* Research clearly shows inflation has high level of persistence ([Pivetta & Reis, 2007)](https://www.sciencedirect.com/science/article/pii/S0165188906000972?casa_token=aFReVYH4CB4AAAAA:ubgQp5lTSx3bUtNTkCmUoxbvvS6PpScVWOhm0n9ox706hYvSXpUEjrWdyDIYo19tonSsMJV8riw). Hence, any change in interest rate now will take time to have effect. It is *technically* completely possible that the current hike was sufficient to bring inflation to Fed's desired level and we just don't know it yet. It is also possible, it is not sufficient of course, but here the first two points kick in.

PS:

Even if inflation will be lowered to [Fed's goal of 2%](https://www.federalreserve.gov/faqs/economy_14400.htm), that does not mean prices will come down. Inflation, is positive increase in prices, so even with 2% inflation prices will be increasing just not as fast as they are doing now.

For prices to decrease there would have to be deflation, and that goes against Fed's objective of keeping inflation at 2%. Hence, unless policy is changed, or economy will be in liquidity trap (situation when monetary policy is ineffective) and there will be deflation due to other factors, Fed will always step in to prevent deflation. So it is extremely unlikely the prices will decline, they will just stop increasing at such high rate.

> **Comments:**
> **username_0**: if what u say is right, inflation is persistent, then wouldn't a spike in rate be better strategy? maybe it's persistent b/c they don't spike the rate. as for ARM that's a good point, but there is a cap too.  
> **username_0**: nevermind ARM, existing fixed mortgages are a real headache for the lender.  
> **username_3**: @username_0 no, because if there is persistence then even if there is high spike, it will take time for the spike to lower inflation and by time inflation is lowered they might discover they lowered it too much. Remember Fed tries to keep inflation around 2% that is their goal. They get criticized/applauded depending on how well they can achieve that while keeping economy stimulated during recession. They don't want inflation to be 1% and they want to avoid deflation at any cost  
> **username_0**: "Only about 10% of total mortgage holders have ARMs. The percentage was only about 5% before 2021. "  
> **username_3**: @username_0 yes, so? 1. That was just an illustrative example, nowhere I make claim that this is the single most important issue, nor I am even claiming its the most important issue now (mortgages were bigger issue in 2009). However, its an *example* of problems central banks can indirectly worry. Currently the issue is that regulation promoted banks to buy government bonds (as they get zero risk weight) but although the default risk of gov debt might be zero, interest rate risk is high, which is creating massive unrealized losses for banks. But there are other issues with business debt etc  
> **username_3**: 2. I also never said this is the sole reason why slow interest r adjustment makes sense. Its one of three main reasons. I did not order the reasons in terms of importance, if I would do so I would say 3 is the most important 1 second and 2 third although they are all quite important  

---

### Answer by username_4 on 2023-03-27. Score: 0

Search Disinflation vs deflation as to why prices haven't gone down. The rate of inflation has decreased,but past inflation hasn't been corrected. As to why not do it all at once, you'd have a lot more banks crashing if that were to happen. You need to give the market time to adjust.

> **Comments:**
> **username_0**: Thanks. Do you have any proof that banks would crash with a sudden jump in rate? model data would work...  
> **username_4**: It's quite simple, we just need to see why they crashed now. A lot of banks keep money in long-term bonds. Let's say I buy one billion dollars worth of 10 years bonds at 1.5% per year. Overnight the fed raises the rates by 3%. Now, the 10 year bonds are at 3.5%. My bonds just went from being worth a billion dollars on the current market to half a billion dollars in the current market. The bank can't pull out, it's too much of a loss. They can't lower interest rates, they need to stay competitive. If you raise the rates slowly, you give the market (and the banks) time to adjust. If not...  

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