Inflation has become public enemy No. 1, and the U.S. Federal Reserve has put a big, broad target on its back.

The Fed is desperately attempting to battle fast-rising prices on everything by raising its short-term interest rates yet again on Wednesday—this time by 0.75 basis points, or three-quarters of a percentage point. But what impact will these continued salvos have on America’s already stressed housing market? And how closely are housing and inflation tied together, anyway?

Inflation, it has become exceedingly clear, is one of those things that everyone knows, most people fear, but few people truly understand. Even fewer are aware of the outsize role that the housing market plays in driving it up. And how, in order to tame it, the Fed will first have to get the runaway prices in the housing market under control—even if it means making things a whole lot worse before they get better.

Confused? You’re not alone. But here’s a simple fact: The Fed’s attempts to wrangle inflation are expected to make the cost of buying or renting a home more expensive for now. That’s expected to push the inflation the Fed is fighting even higher.

“Is it the chicken or the egg? The rising rates are causing housing prices to rise,” says Kelly Mangold, principal of RCLCO Real Estate Consulting. “The Fed is seeing that rise, and the Fed is raising its rates more to temper this.”

Inflation makes it difficult for consumers and businesses to accurately budget for the future. It also discourages saving as money is worth less in the future. Many folks won’t want to wait on buying something if the cost is expected to increase if they wait.

The Fed’s goal in raising its rates is to make it cost more for consumers and businesses to borrow money, such as putting a purchase on a credit card, so that demand falls. That should help stabilize prices.

But it’s a delicate dance as every increase pushes the nation’s economy even closer to another recession. And while the Fed can influence demand, it can’t control the supply chain problems and the war in Ukraine, which have made many coveted items more scarce.

So what exactly is inflation? And what sort of role does housing play in it?

How does the Fed measure inflation?

The Fed measures inflation mainly through the Consumer Price Index. The U.S. Bureau of Labor Statistics measures the prices over time of about 200 categories of goods and services like food, energy, cars, apparel, medical care, and housing.

Last month, inflation spiked 9.1% compared with a year earlier. A healthy annual inflation rate is only about 2%.

The Fed also looks at the Producer Price Index, which looks at the inflation experienced by producers and businesses. The prices of construction materials such lumber, drywall, and windows are included in this index.

Housing, which includes rents and the estimated costs of homeownership, makes up about a third of the goods and services that are measured for inflation. It rises to over 40% if furniture and utility bills are factored in. So when people spend more to renew their leases or the prices of homes for sale spike, it shows up in the inflation data that the Fed monitors closely.

“Housing leads the economy,” says Robert Dietz, chief economist of the National Association of Home Builders. “Housing is often the first sector to experience weakness during a recession, but it’s often the first sector to rebound as well.”

Why the Fed is making the housing market even more expensive as it attempts to cool it down

Ironically, the more the Fed raises its rates, the more expensive housing becomes. That heightens inflation even further. Since the Fed’s main tool to fight fast-rising prices is to raise its rates, it can become a bit of a spiral.

When the Fed raises its short-term rates, mortgage interest rates generally follow a similar trajectory. They tend to bump up each time the Fed announces another rate hike. As mortgage rates go up, it becomes more expensive to borrow money to buy a home. That prices many would-be buyers out of the market.

The Fed is betting this will temper the out-of-control price growth seen since the COVID-19 pandemic began. In one sense, it’s already working: The housing market has slowed down, sellers are slashing prices, and bidding wars are dissipating.

However, everyone still needs a roof over their heads. So many folks who can’t afford a home of their own are renting instead. And when there’s more demand for rentals, prices rise.

Since housing plays a pivotal role in the budgets of most Americans, when those prices rise, so does inflation.

Complicating matters is that rents typically rise only when tenants renew their leases, once a year or every two years. With inflation soaring, that means higher rent increases likely won’t show up in the inflation report for another quarter or two.

“For the Fed, that’s tough,” says Dietz. “Housing is going to be a lagging contributor to inflation in the future.”

The biggest driver of high housing costs is that there aren’t enough homes to go around for both buyers and renters—not even close. When there’s more demand than supply, prices go up. That’s not something the Fed can fix.

“They’ve got a tough challenge,” says Dietz. “We know if we truly want to tame inflation within the housing sector, that means additional homes [are needed] for people to rent and buy. The Federal Reserve can’t do that.”

Will the Fed continue to raise rates?

The big question is whether the Fed will continue to raise rates—increasing the likelihood of another recession.

“My guess is they’ll have to raise rates one or two more times,” says economics professor Lawrence J. White, of New York University.

Critics have accused the Fed of allowing inflation to get out of hand before taking steps to get it under control.

“They were too lenient for too long,” says White. “They took too long to realize that inflation was a problem. They don’t want to be caught on the other side, prematurely easing up and causing inflation to rekindle.”

In another twist, if the Fed fails in delivering a “soft landing” for the economy and it slips into a downturn, then it will likely start slashing rates once again.

“They’ll raise them until we get to the intended impact of tempering inflation,” says RCLCO’s Mangold. “But then they’ll probably level them off or begin cutting them depending on how the economy is responding.”

The Fed is also to blame for inflation

Supply chain snafus and shortages, the war in Ukraine, and stimulus payments that Americans received during the pandemic have been cast as the Big Bads when it comes to inflation. But some economic experts are blaming the Fed as well.

The Fed increased the amount of money in circulation during the pandemic as it purchased bonds. Interest rates dropped. This helped lead to rock-bottom mortgage rates, which then spurred a rush on the housing market and led to sky-high home prices as demand for homes soared. This pushed up rents when would-be homebuyers were priced out of the market and needed places to live.

“Prices go up when we have more money in circulation,” says economics professor Antonio Saravia, of Mercer University in Macon, GA. “If we have all of this money floating around in the economy, what do people do? They go shopping, chasing the same number of goods and services with more cash. As a result, prices go up—and that’s how you get inflation.”

The Fed raising interest rates and selling more U.S. Treasury bonds is expected to reduce inflation. If it costs more to borrow money or put something on a credit card, consumers and businesses are likely to spend less.

“Now that the loans are more expensive, people are going to buy fewer houses,” says Saravia.

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