ORLANDO, Fla., July 13 (Reuters) – The Fed and the US economy are entering a rough patch.
Depending on the length of the “long and variable” lag in monetary policy, a good portion—perhaps most—of the 500 basis points of Federal Reserve rate hikes since March 2022 is yet to be felt in the real economy.
As the US Federal Reserve nears “maximum interest rates,” policymakers, consumers, businesses and financial markets find themselves in limbo – grateful for the “soft landing” that appears to be underway but aware that the full impact of the tightening cycle is yet to be felt pending coming.
The amorphous lag explains the game of cat-and-mouse between the Fed and markets since the start of the central bank’s tightening cycle last year.
To ensure inflation is dead and buried, Fed officials have attempted to keep rates markets from easing financing conditions and distance them from their long-held view that policy will be eased almost as soon as the final rate is reached.
For their part, markets have long expected the Fed to quickly launch a fairly aggressive series of rate cuts, primarily to counteract the accumulated lagging effects of the tightening cycle.
With consumer price inflation falling dramatically to 3% on an annualized basis and the Fed’s rate-hiking campaign nearing its end, the “long and variable” lags that economist Milton Friedman coined in 1961 are now coming under closer scrutiny.
Reuters image
NEW RULES OF THUMB
An old rule of thumb states that it takes around 18 to 24 months for monetary policy measures to have an impact on the real economy. Literally, the 500 basis points of tightening since March 2022 – ie 17 months ago – is still not registered at all.
This would indicate that employment will be severely hit and growth will falter. Of course, it’s not that simple, as the implementation of more restrictive policies happens faster in the modern world via forward guidance, falling asset prices and tighter financial conditions.
There is a growing body of opinion that the delays have shortened significantly since Friedman presented his “long and variable” theory.
Fed Governor Christopher Waller said in January that monetary policy now has an impact in 9 to 12 months, and a December paper from the Kansas City Fed concluded that “the sharpest slowdown in inflation was about a year after monetary policy Tightening could occur,” although she stressed “high” “ambiguity about it.
This would mean that rate hikes of 200 to 275 basis points – the cumulative tightening since last July 12 months ago or since September nine months ago – are yet to be felt.
Last September, the Fed raised its target for federal funds to 3.00% to 3.25%, above what its officials consider a “neutral” interest rate of around 2.5%, which neither boosts nor slows the economy .
If policy has been tightening all along but not fully felt yet, while inflation has fallen from 9% to 3%, it’s safe to assume the Fed’s job is pretty much done.
With inflation falling towards its target, slowing at its fastest pace in 100 years, and unemployment near its 50-year low, the central bank is on the verge of hitting its dual mandate targets.
Reuters image
Data on Wednesday showed consumer prices rose at an annual rate of 3.0% in June, compared with 4.0% in May. Annual inflation has now slowed for 12 consecutive months from a 41-year high of 9.1% last summer, the longest straight decline since June 1920-June 1921.
“The disinflation process has been rapid and is now well advanced,” economist Phil Suttle wrote on Wednesday.
With policy delays still to come, discussion is now likely to focus on how much of the 150 basis points of rate cuts by the end of next year that are priced into rates markets will actually materialize.
(The opinions expressed here are those of the author, a columnist for Reuters.)
By Jamie McGeever; Edited by Paul Simao
Our standards: The Thomson Reuters Trust Principles.
The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and impartiality under the Trust Principles.
Comments are closed.