Happy Fed Week! After the tumultuous last two weeks, which saw the most severe bank failures since the Global Financial Crisis, this week we will have a highly anticipated FOMC meeting with an anxiously expected Fed Interest rate decision due on Wednesday. Considering the current Fed rate hike path and inflation dynamics, I decided to write this article to look through the previous Fed rate hike cycles.

The Highest Inflation Rate in the Last 40 Years

Let’s start with analyzing the historical values for the Fed reference rate and inflation. As a measure of inflation, I will use the (Headline) CPI YoY. Whereas, for the Fed reference rate, I will use the Fed Funds Target rate. Note that the FOMC funds rate targeting started in October 1982 as outlined in this working paper. Moreover, in 2008 the FOMC switched its process from rate targeting to rate range targeting with a lower and upper limit. Accordingly, for the purpose of this article, I linked the Federal Funds Target Rate (until 2008) with the Federal Funds Target Range - Lower Limit (from 2008).

In this first chart, we can see that the rampant inflation that started in the aftermath of the COVID-19 pandemic reached a peak of about 9%, corresponding to the highest value of the last 40 years. It is interesting to note that this period of sky-high inflation in the US also corresponded to a period of extremely low interest rates with the lower limit of the target range equaling 0%. This resulted in the most negative real interest rate of the analysis period.

With the Fed aiming for an inflation target of 2%, it started its monetary tightening campaign in March 2022 with the first reference rate increase of 50 basis points. As shown in the chart, it was an extremely fast hike path, with the reference rate having increased by 4.50% in less than one year. Keeping that in mind, I believed that it would be insightful to compare the speed of the current hiking cycle with the previous ones.

The Fastest Fed Rate Hike Cycle Ever

In order to show the different Fed rate hiking cycles, I defined that the hiking cycle starts at the time of the first reference rate increase, and it finishes when more than two interest rate cuts are implemented. Also, for it to be considered a cycle there must be more than one interest rate hike.*

Here we can see that the current rate hiking cycle (2022-2023) was the fastest ever with the Fed reference rate increasing by the aforementioned 4.50% in less than one year. A straightforward explanation for this occurrence is the fact that before these monetary policy actions, the rate was at 0% and, therefore, probably requiring a much higher increase to get the reference rate back to “normal” levels.

Curiously, the current hiking cycle contrasts with the previous one (2015-2018) which was the slowest and also took place after a period of zero interest rate policy (ZIRP). However, between 2015 and 2018 the inflation rate stayed close to the Fed’s target of 2% with the highest instance not even reaching 3%. Finally, given that the primary goal of monetary policy tightening is to cool down inflation, I thought that it would be interesting to replicate this chart but show the change in inflation instead.

Fastest Inflation Rate Decrease Ever too?

So far in this article, we have been through the superlatives: first the highest inflation in the last 40 years, and then the fastest Fed rate hike cycle ever. So now I suppose the reader is wondering if this also resulted in the fastest inflation rate decrease ever. Well, in fact from this last chart, we see that in the 2004-2006 rate hike cycle the initial decrease in inflation was relatively faster than the current one. Actually, in the current cycle we see that there was a hiccup with inflation climbing in two months after the initial reference rate hike of 50 basis points.

Notwithstanding, after that initial setback, inflation started strongly decreasing having declined by about 2.5% so far. This result highly contrasts with those of the previous cycles where in fact we don’t see such a swift and orderly decrease in inflation. Lastly, at this point, I questioned myself: Can the Fed claim that it was successful in its monetary policy this time by taming inflation? Or was this just a consequence of the extremely high inflation that would have normalized anyway? That is up for a lot of discussion…

*These rules were put in place to accommodate for 1983-1984 to be one cycle and to distinguish the 1987 cycle from 1988-1989.

Sources

Data Source: FRED , Board of Governors of the Federal Reserve System (US), retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/

Code Source: GitHub Page

Cover Image Credits: © kittysfotos/ ID: 43829892684/ Flickr.com

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