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Federal Reserve Hikes Key Interest Rate to 5 Percent

In an effort to curb the growing rate of inflation, the Federal Reserve raised a key short-term rate to a five-year high of 5 percent and warned that future interest rate increases may be needed. Economics correspondent Paul Solman discusses the reasoning behind the Fed's rate hike.

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  • JIM LEHRER:

    The Federal Reserve's decision to raise interest rates again. Our economics correspondent, Paul Solman, is with us to explain the action and the reactions to it.

    Welcome, Paul.

  • PAUL SOLMAN, NewsHour Economics Correspondent:

    Nice to be here, Jim.

  • JIM LEHRER:

    First, remind us about this interest rate that the Fed actually raised today. What is it, and what does it touch?

  • PAUL SOLMAN:

    It's the overnight rate that banks charge each other, which wouldn't seem like it was all that important, except that all short-term interest rates are basically pegged to that, based on that — not all, but many — and therefore it means that, when they raise rates by a quarter of a percentage point, interest rates in general rise by a quarter of a percentage point: your home mortgage; your home equity loan, if it's variable; the next mortgage you take; your car loan; and so forth.

  • JIM LEHRER:

    All right. And the Fed has done this 16 times now over the last couple of years.

  • PAUL SOLMAN:

    Right. That's right.

  • JIM LEHRER:

    And it's all aimed at doing something about inflation. Explain the rationale.

  • PAUL SOLMAN:

    You don't want the economy to overheat. The famous cliche is: You take away the punch bowl before the party gets too crazy, before it gets too wild, before the economy gets overheated. People start spending too much. Their wages, they then start to ask for higher wages because prices go higher.

    Inflation is just a rise in prices in general that distorts the economy, since in a market economy is based on prices, and prices signaling what we want, that's a distortion. You hate inflation; all economies hate it.

    Enough inflation, and you paralyze an economy. That's the Fed's main job: making sure inflation doesn't happen.

  • JIM LEHRER:

    And the cause and effect between interest rates and inflation?

  • PAUL SOLMAN:

    Well, the idea is that, if you raise interest rates, you discourage people from spending more money. You're going to spend less money, presumably, if you're borrowing. A business is going to spend less money because it costs more.

    The interest rate is just the price of money, right? So you raise the price of money. You slow down the economy. Thereby, you moderate, you tighten, and, therefore, you dampen inflation. That's the whole idea.

  • JIM LEHRER:

    OK, got it. Now, the decision today — yes, thank you, sir.

  • PAUL SOLMAN:

    That's what I'm here for.