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Raising interest rates can help curb inflation, but at a cost

Metro Denver's median home price hit $400K in February; housing inventory on the rise
Posted at 5:48 PM, May 31, 2022
and last updated 2022-06-01 10:11:06-04

DENVER — President Joe Biden met with Federal Reserve Chairman Jerome Powell Tuesday to discuss ways to combat rising inflation.

Consumer inflation was up 9.1% in the Denver area as of March, according to data from the U.S. Bureau of Labor Statistics. That is the largest price jump in more than four decades.

The president wants to slow inflation without triggering a recession, which can be a difficult needle to thread.

“What we've seen in the last 12 months is that inflation is now running really hot. This is hurting the average Coloradoan, and this is impacting Colorado households,” said Chris Brown, vice president of policy and research at the Common Sense Institute. “What you want is stability, and when you don't have stability, and you have uncertainty and rapidly rising prices, this puts a crunch on everybody.”

CSI estimates the average Colorado household spent $4,467 more since 2020 because of inflation. Overall, its data has found that price levels have increased 2% between January and March.

Inflation disproportionately impacts lower-income families, according to Kishore Kulkarni, a distinguished professor of economics at Metropolitan State University of Denver.

“In inflation, when the prices go up, our wages don't catch up and we lose our real income,” Kulkarni said.

The best way to help families is to bring down inflation so that their dollars stretch further and they are better able to afford everyday items, like groceries and gas. The main tactic used to level out inflation rates is to make interest rates go up. When that happens, borrowing goes down, which limits the amount of money going out.

“If you're borrowing money, you're going to pay a higher amount to borrow that money," said Scott Wasserman, president of The Bell Policy Center.

So far, the Federal Reserve has already raised interest rates by .5%, and is hinting at raising them several more times this year.

However, for low and middle-income families looking to buy a home, there is a double-edged sword to raising interest rates.

Because interest rates have been low for so long, more families have gotten into the housing market and are able to take out a bigger mortgage with a smaller monthly payment. If the interest rates continue to rise, that will no longer be an option.

“We have way too many people in the market buying too many homes, and that's why the house prices have gone up,” Kulkarni said.

While it will help lower inflation and help with day-to-day items, the rising rates could price some families out of the housing market altogether, or cause others to rethink what they can afford.

“My fear is that for middle-income Coloradans, it will be harder for them to get the mortgage that they need in order to afford that home,” Wasserman said.

It’s a concern Brown shares as well for new homebuyers and middle-income families. He wants to see more focus on development options, like shoring up the supply chain and creating more affordable housing.

Wasserman, meanwhile, wants to see policymakers target relief to the people who need it most rather than companies or wealthier individuals who can handle some of the increased costs. He also says it’s a good time for families to see whether they have an adjustable mortgage and if they can switch to a fixed rate before interest increases too much.

The bottom line is that the Biden administration and federal government are looking at taking serious steps to curb inflation. If they are successful and avoid a recession, they could help stretch the dollars of families further, but it comes with a short-term cost.