Demissew Diro Ejara: Caution should be exercised in economic decisions

Several economic facts have been reported in the past weeks.

The inflation rate is 9.1% year over year. Gross domestic product (GDP) declined by 0.9% during the second quarter of 2022. Since GDP declined by 1.6% in the first quarter, the sequence officially makes the economy in recession. The National Bureau of Economic Research defines recession as decline in aggregate economic activities for two consecutive quarters. The Federal Reserve Bank, the monetary policy-making body of the United States, increased the target federal funds rate by 0.75% to the range of 2.25%-2.5%. The goal of interest rate increase is to fight inflation.


On the positive side, the unemployment rate is at a historic low of 3.6% and many vacancy announcements are posted at job sites. Both Jerome Powell, chairman of the Federal Reserve Bank, and Janet Yellen, treasury secretary, stated positive views on the economy. The stock market rose despite many companies missing on quarterly earnings reports. The stock market is one of the leading economic indicators. So, the stocks making a turn to green from mostly red during the first half of the year indicates that we have turned a corner. The uniqueness of the current economic situation is that it is mainly caused by the high energy cost due to oil supply shortages related to the war in Ukraine and the shortage of chips to manufacture certain equipment including computers and autos.

The Biden administration released hundreds of millions of barrels of oil from the national reserve to increase supply. It promised to release more as necessary. This might increase the supply and reduce energy prices and hence some inflation. The U.S. Senate has approved $52 billion to support production of chips in the U.S. The bill is expected to be approved by Congress. That also will help overcome the chips shortage and production slowdown in computers and other equipment. This might appear as an expenditure that increases inflation but unlike spending on entitlements, for example, this is being spent on production. Its impact on inflation is minimal.


The increase in oil supply and the Federal Reserve Bank’s interest rate increase might tame inflation. If inflation doesn’t decrease soon, the Fed might increase rates again in September. Since the unemployment rate is low and stock prices are also rising, the Fed can have free hand to tackle inflation. The current inflationary condition will not last long. In a couple of quarters, we probably should see a return to normal conditions. Of course, other factors might arise and change the course of the economy.

Impact on consumers




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Consumers are negatively affected by the rising prices of consumer goods ranging from gasoline to food and housing. The increase in interest rates will increase the cost of consumer loans and discourage borrowing and spending. That is the very intent of the Fed when it raises interest rates. So what should consumers do? Consumers should postpone major purchases if possible.


Home prices increased significantly. If the increase in interest rates brings down home prices, it would be a good buying opportunity. Even if interest rates are high, long-term loans like mortgages can be refinanced later when rates decrease.


Stock prices decreased significantly since the beginning of 2022. The recent rise in stock prices implies that we probably reached the bottom and made a turnaround. It might indicate the beginning of recovery. This is a good time to buy stocks. The selection of specific sectors or stocks depends in general on the investment objectives. REITs and other high-dividend-paying stocks are suitable for income objective. Long-term goals are better met with growth stocks such as technology companies.

There is great uncertainty at the moment. Opinions and economic forecasts might indicate a positive outlook. But caution should be exercised in every decision.


Demissew Diro Ejara is an associate professor of finance at the University of New Haven.