Fed Raises Target Rate Again: Will It Have Time to Normalize Before the Next Recession?

By: Ryan McMaken

The Federal Reserve today raised the the Federal Funds Rate to a target/range of 2.0-2.25 percent:

funds_rate.PNG

According to Business Insider:

The Federal Reserve announced Wednesday, after a two-day policy meeting, that it would raise interest rates for the third time this year.

The decision, which had been widely expected, raised the federal funds rate by 25 basis points, to a range of 2% to 2.25%.

It was the eighth time the Federal Open Market Committee has raised borrowing costs since late 2015. It held rates near zero after the Great Recession to speed up the economic recovery.

Accordingly, the Fed removed language in its statement that had characterized its policy as “accommodative.” Still, Fed Chairman Jerome Powell said at a press conference that the Fed did not have a precise estimate of where accommodation ends.

A look at rates over time shows that at 2.25 percent, the Federal Funds Rate has not been this high since January of 2005. At the time, however, the Fed still had more than two-and-a-half years before indications of an imminent recession led the Fed to begin cutting rates again in September of 2007. Rates peaked during the last cycle at 5.25 percent for 15 months.

It remains to be seen if the Fed will have a similarly broad period of time during which to “normalize” rates after more than seven years of a near-zero target rate. The Fed’s pledge to “unwind” its extremely accommodative monetary policy is still a long way from coming to tuition. The Fed’s balance sheet, after all, remains enormous by historical standards:

balancesheet.PNG

Moreover, if a recession begins within the next year, the Fed will find itself in a place where it will want to pursue “stimulus” by slashing the target rate, but will have to cut rates from a starting point of around 3 percent. That leave considerably less room to move than it had when the target rate was over five percent in 2007.

Moreover, given that most everyone expects the Fed to continue with its practice of buying up assets for stimulus purposes, it will then need to add “underpriced” assets to an existing portfolio of over 3 trillions dollars — even assuming the Fed manages to shed a sizable amount of its portfolio over the next year.

Such moves would be unprecedented in the history of American central banking, and we may get to find out what happens if the Fed tries it.

Note: for additional context, here’s a longer time horizon on the federal funds rate levels. In recent years, the federal funds rate has been spending more and more time at rock-bottom levels, and with a result of arguably more anemic growth in real incomes.

funds_rate_2.PNG

Powered by WPeMatico