The federal government is going to allow inflation to increase above a rate of two percent for a brief period to help the economy as it continues to recover from its most recent recession. But what does that mean for the average American and how they spend or save?

What A Higher Rate Of Inflation Means

Typically, the government targets a two percent rate of inflation to keep the prices of products stable relative to what people earn.

The government can make decisions that either speed up or slow down that rate of inflation. By allowing inflation to rise above two percent, the fed is allowing consumers to spend more. By spending more, they have less money tucked away for a rainy day, AKA a recession. This makes consumers more vulnerable to a recession.

How Slowing Inflation Helps The Public

What makes a recession difficult for the public to cope with is the dramatic shift in spending ability. By controlling inflation, the fed seeks to make the shock of a recession less jolting.

The fed can affect inflation in three ways: by raising interest rates, increasing reserve requirements, and reducing the money supply.

How The Fed Slows Down Spending

When the fed increases interest rates, banks must raise interest rates as well. This leads to people saving money rather than taking out bank loans and spending it. Higher interest rates discourage spending. This helps people stay prepared for the impending recession.

When the fed increases reserve requirements, they increase the amount of money that banks have to have in reserve. If the banks have to hold onto more money, that means there’s less to loan out. As a result, the public spends less and is better prepared for a recession. The fed can also reduce the money supply so that there’s less money to go around. This has the same effect: consumers spend less.

For now, the fed won’t be using any of these tactics. Instead, they’ll let inflation rise above the normal rate of two percent, and it doesn’t seem to be cause for concern, as the Federal Open Market Committee is still optimistic about the economy’s current trajectory. 

“They noted a number of economic fundamentals were currently supporting continued above-trend economic growth; these included a strong labor market, federal tax and spending policies, high levels of household and business confidence, favorable financial conditions, and strong economic growth abroad,” minutes from the May 1-2 session noted.