The Fed’s Tightening Seems to Have Little Impact: What’s Going On?

The Federal Reserve has been on a rate-hiking cycle for the past year, raising interest rates by 4.5 percentage points and shrinking its balance sheet by more than $600 billion. While the Fed has moved more aggressively than many expected, the economy remains strong, with a five-decade low in the unemployment rate and inflation still above the Fed’s goals. This raises important questions about the Fed’s ability to accomplish its price stability goals.

Why does the Fed’s Tightening have Little Impact?

The Fed’s actions have affected financial markets, with last year’s steep drop in the stock market and higher rates on corporate bonds and mortgages. However, across the broad swath of the economy, consumer demand and overall hiring have remained extraordinarily healthy. One theory is that long, slow-moving trends cause interest rate movements to have less impact than in the past. Research conducted during that era pointed to structural changes in how companies operate, reducing their sensitivity to interest rates. Moreover, changes to short-term interest rates set by Fed policymakers don’t flow through to long-term rates that affect economic decision-making as much as in the past.

The Fed Chief’s Response

When asked about the narrowness of the economic response to higher rates, the Fed chief emphasized the strength of the job market and consumer balance sheets. Chair Jerome Powell said, “We go into this with a strong labor market, and excess demand in the labor market … and also with households with strong spending power built up. So it may take time, it may take resolve, it may take patience.” However, four months later, there are still few signs of a meaningful slowdown, and interest rate policy seemed to pack little punch in the last economic cycle.

Related Facts

• The Fed’s target interest rate is currently set between 2.25% to 2.5%.
• The Fed’s policy-making committee, the Federal Open Market Committee, meets every six weeks to determine interest rates and other monetary policies.
• The Fed’s dual mandate is to maintain full employment and price stability.
• During the Great Recession, the Fed lowered interest rates to near zero and implemented large-scale asset purchases to stimulate the economy.

Key Takeaway

The Fed’s recent tightening cycle has had little impact on the economy, despite raising interest rates by 4.5 percentage points and shrinking its balance sheet by more than $600 billion. Structural changes in how companies operate and the reduced sensitivity to interest rates could be a factor. Nevertheless, interest rate policy seemed to pack little punch in the last economic cycle, raising important questions about the Fed’s ability to accomplish its price stability goals.

Conclusion

The Fed’s tightening cycle has raised important questions about its ability to meet its price stability goals. While the strong labor market and consumer balance sheets entering this period are positive signs, there are still few signs of a meaningful economic slowdown. Moreover, the structural changes in how companies operate and reduced sensitivity to interest rates suggest that the Fed’s rate-hiking cycle may not have the same impact as seen in the past.