Why the Fed's current campaign to raise interest rates is almost unprecedented

– by a New Deal Democrat

How unprecedented is the Fed’s current policy of raising interest rates? Since the Federal Reserve began actively managing the fed funds rate in the late 1950s, only two other cases have been similar.

The reason the Fed raises interest rates is to fight inflation. But, as I’ve pointed out in the past, the post-pandemic boom is very similar to the boom immediately following World War II. In 1947, faced with 20% annual inflation, the Federal Reserve did nothing—in fact, nothing. He raised the discount rate from 1% to 1.5%:

The prices stabilized on their own after reaching the limit of ordinary users. In 1948, there was a brief recession caused by inventories, and the economy continued to move forward.

In 2022, the Fed raised interest rates by 4% over the last 10 months of the year, one of the most aggressive rate hikes in history, as shown in the chart below of the annual Fed rate change :

Inflation peaked in June. Since then, the Fed has continued to raise rates by 2.75%:

Not only was the 2022 rate hike regime among the most aggressive, it was unusual in another way. As shown in the chart below, in all but two of the other significant cases, the Fed raised interest rates to coincide with *rising* inflation. The Fed stopped raising interest rates before, or at most shortly after, the inflation peak:

Indeed, usually once inflation begins to decline, the Fed begins to *cut’ rates, usually in the face of a weakening economy. In contrast, last year the year-over-year change in the CPI peaked in June. Since then, the Fed has raised rates by another 2.75%.

There have only been 4 other times in the past 60+ years that the Fed has continued to raise rates after inflation has peaked. Two of these were barely significant, involving rate hikes of only 0.5%. In 1997, the Fed funds rate increased from 5.25% to 5% as inflation fell from 3.4% to 1.4%. In 2018-19, the Fed funds rate was increased from 2% to 2.5% as inflation declined from 2.9% to 1.5%. None of them were recession-related (the 2020 recession was caused by the pandemic).

Two other times involved rate hikes of 2% to 3% or less that were associated with slowdowns but no recessions. In 1984, the Fed funds rate was raised in 5 months from 9.5% to 11.75% as inflation fell from 4.9% to 4.3%:

In 1994-95, the Fed funds rate was raised from 3% to 6% in 17 months, even though inflation only ranged from 2.8% to 2.3% to 3.1%:

There was a sharp slowdown—enough, perhaps not coincidentally, to help the GOP gain a majority in the House for the first time since the Great Depression—but no recession.

By far the biggest episode occurred in 1980 and 1981. In April 1980, the Fed funds rate peaked at 17.5%, just as inflation peaked at 14.6%. Then, despite inflation falling to 13.2%, the Federal Reserve under Paul Volcker resumed a campaign to raise interest rates, going from 9% to 19%, although inflation continued to cool to 9.7%. The deep recession of 1981-82 followed, with unemployment rising above 10% for the first time since the Great Depression:

The Fed’s current rate hike is more serious than any since the 1980-81 hikes. And even in 1994, inflation was mostly sideways, not down. That leaves only the 1984 episode as the only other truly comparable one.

Using core inflation, the situation is the same, except that inflation has not fallen significantly at the moment, solely due to the prominence of the heavily lagging owner-equivalent rent measure, which makes up 40% of the measure:

It’s similar if I use the core personal consumption expenditure deflator, except in 1969 when the Fed continued to raise interest rates in a recession as the core deflator peaked but stabilized there. In our current situation, the core deflator decreased by -0.5% from 5.2% last February to 4.7% in November:

To recap: Over the past 60+ years, the Fed has typically raised interest rates only when inflation was rising and stopped or reversed course once inflation began to decline. A few of the exceptions are not significant, including interest rate hikes of 0.5% when inflation falls. One (1994) involved raising interest rates in the face of relatively flat inflation, and of the other two, one (1984) contributed to a sharp economic slowdown without recession. The other (1980-81) contributed to one of the two worst recessions since the Great Depression and was justified by Volcker as necessary to eradicate inflationary expectations and the wage-price spiral.

There is very little evidence of any wage-price spiral or embedded future expectations at present. Yet the Federal Reserve continues to raise interest rates, even though inflationary pressures have eased (and outside owner-occupier rent equivalents appear contained).

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