Federal Reserve’s Interest Rate Journey
The U.S. economy, in the wake of the COVID-19 pandemic, has confronted extraordinary difficulties. The inflation rate surged to over 7% in 2022. Meanwhile, the Federal Reserve, whose job it is to keep stability in the economy, began a steep climb to raise interest rates in this inflationary time. Eleven hikes in just 16 months have been the result so far. As of September 2023, the Fed has decided on an important policy move: to lower its target range for the federal funds rate by half a percentage point. In this article, I will ask and attempt to answer the question: Can the Fed keep the soft landing achieved so far and avoid a recession?
Inflation Challenges Post-Pandemic
In this piece, we argue that even though strides have been made to avoid further inflation and that the current economic situation isn’t as bad as it could be, things could still go south in a hurry. When the Federal Reserve talks about the “balance” it must strike between stimulating the economy and keeping inflation under control, we must understand just how re-balancing is avoided at “all costs” on behalf of everyday Americans. The Fed doesn’t have to wish us well quite so much if the alternatives it avoids come at a high price.
Labor Market Concerns and Economic Stability
The Federal Reserve’s decisions are not simply theoretical exercises; they have real-world effects on the lives of millions of Americans. As interest rates rise and fall, so do the costs associated with our most important loans, such as for houses, cars, or our day-to-day credit. The most recent report from the Bureau of Labor Statistics said that the U.S. economy added only 142,000 jobs in August—a sharp decline from the previous few years and a further indication that the labor market is cooling. Some economists warn that if the Fed keeps pushing up interest rates, it could push the unemployment rate higher too. Fed Governor Mickey Bowman and Kansas City Fed President Jeff Schmidt have framed the discussion as a balance between restoring inflation to the 2 percent target and keeping the job market in good shape.
To grasp the present state of affairs, one must contemplate the direction of Federal Reserve policies these last few years. The Fed started 2022 holding the line on interest rates, keeping them at virtually zero. But in a response that caught many by surprise, the central bank pivoted to hike rates—fast and furiously. By July 2023, the Fed had lifted its short-term rate to between 5.25% and 5.5%, the highest level we’ve seen since just after the 2008 financial crisis. And unlike the 2008-2009 experience, this time the economy has not cratered. The cooling that has occurred has been in the inflation numbers. Inflation is down to a pace around 2.5%.
Future Outlook and Potential Recession Risks
Operating under a dual mandate, the Federal Reserve promotes maximum employment and seeks price stability. These days, the questions being asked signal not-so-great times ahead. Recently, the unemployment rate has inched up, and job creation has stalled. At the same time, some businesses have curtailed their hiring plans, and a serious rethink of the labor market has begun. Fed officials say their focus must, for the time being, stick with the jobs side of the equation. These same officials also contend that aggressive rate cuts are the best means not only of maintaining the focus on jobs but also of keeping inflation under control. We assuredly don’t want to walk the tightrope that leads to 1970s-style stagflation. But the tendency of the recent past to hit the rate-cut button isn’t much of a plan, either.
The Federal Reserve’s decisions hit the average American directly in the pocketbook. Lower rates help every consumer, as we all are when we borrow money. We are persuaded to borrow more when rates are lower. Consequently, as the average American sees it, lower rates are good for business and are far better than the alternatives. But what the average American sees as a good is nothing but an act of monetary magic—a sleight of hand or a pulling of strings—that could lead to dire consequences: joblessness and a loss of income for the average American, a drop in consumer confidence, and the potential for a recession. Unemployment is already too high.
Critics might maintain that the Fed’s slow-and-steady approach borders on the too conservative and that the recent run of insufficiently low interest rates need to be knocked down several pegs more to truly get the economy going. There is, however, some pretty solid historical evidence that impetuous monetary policy—especially impetuous rate-cutting—can lead to some pretty nasty economic hangovers. The most vivid cautionary tale from recent American history, of course, is the combination of high inflation and stagnant economic growth that began to unfold in the middle of 1973 and didn’t start to unwind itself until the beginning of 1983.
The Federal Reserve is moving ahead, and the stakes could not be higher. The balance it is trying to strike between taming inflation and fostering a growing job market is not easy, and it demands both foresight and deftness. The next several months should make it clearer whether the Fed is going to stick the landing or tank. It is a big deal, because if the outcome is anything like what we have feared, the direct and lasting consequences will fall right on top of the heads of the Americans living today and those yet to be born. The waters the Fed is navigating are choppy and full of uncertainty. The price stability and full employment pathway is fraught with enough challenges that the Fed must proceed with caution and wisdom.