The Federal Open Market Committee (FOMC) raised the federal funds rate by 0.75% to a new target range of 3.75% to 4.00% this week in its ongoing effort to fight inflation. The federal funds rate controls the rates at which depository institutions lend each other money overnight, and the rate has downstream effects on business and consumer loans. A higher federal funds rate will make it more expensive to borrow money.
The Fed is rapidly raising rates because of significant price increases across the economy. The most recent Consumer Price Index (CPI) data from September shows that prices have risen 8.2% year over year. Monetary policy is being tightened in an effort to drive down demand and restore price stability, but by slowing down economic activity, the Fed could cause a recession in the process.
In his opening statement, Chair Jerome Powell reiterated that “price stability is the responsibility of the Federal Reserve, and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone.”
With a 75 basis point increase at the November meeting, the FOMC met the consensus expectation for how much they’d raise the federal funds rate, according to the CME FedWatch Tool. But while observers were more interested to see if Powell would give any clues to the path of future rate increases, this appears to be much more uncertain.
When asked about the rate increase coming at the December meeting, Powell said that he wanted to put the question of pace in the context of other questions, including how high to raise the rate and how long to keep it there.
“It’s been very important that we move expeditiously and we have clearly done so,” said Powell. As for how high to raise that policy rate, “we’re saying that we’d raise that rate to a level that’s sufficiently restrictive.”
“At some point it will become appropriate to slow the pace of increases. That time is coming, and it may come as soon as the next meeting or the one after that.”
In its most recent Summary of Economic Projections (SEP), released back in September, the committee members overwhelmingly forecasted that the federal funds rate target range would land between 4.25% and 5.00% in 2023. However, though those projections suggest that rate increases will slow or stop fairly soon, further economic data could complicate things. If October and November price data doesn’t look favorable, the Fed could revise those expectations upwards in the December SEP.
Until March of this year, the federal funds rate had been set at the zero-bound range — even as inflation started to take hold. Year-over-year CPI inflation began to climb in 2021, reaching 7.0% in December of that year. By March 2022, the number had risen to 8.5%, and the Fed has acted aggressively since then. But while inflation has fallen slightly since its June peak, at 8.2%, it’s still much higher than the Fed’s long-term target (2.0%).
The Fed has consistently noted that supply-related constraints have contributed to inflation, specifically citing the ongoing effects of Russia invading Ukraine. While raising rates can decrease aggregate demand and ease price pressures, the Fed doesn’t have the tools to address supply issues. Even though there are some hopeful signs — energy prices have been falling, for example — inflation may persist despite the Fed’s efforts.
Even as inflation continues to dominate the headlines, the U.S. labor market has remained very strong. The unemployment rate fell throughout 2021 and has remained below 4.0% since January 2022, as job openings have remained high and labor force participation has remained low.
It’s another imbalance between supply and demand that pushes the cost of labor upwards as employers compete for workers. The Fed hopes that the labor market can soften without a spike in unemployment given the amount of open jobs relative to the number of job seekers.
Here is the FOMC’s calendar of scheduled meetings for 2022. Each entry is tentative until confirmed at the meeting proceeding it.
January 25-26, 2022
March 15-16, 2022
May 3-4, 2022
June 14-15, 2022
July 26-27, 2022
September 20-21, 2022
November 1-2, 2022
December 13-14, 2022
Here is the FOMC’s calendar of scheduled meetings for 2023. Each entry is tentative until confirmed at the meeting proceeding it.
January/February 31-1, 2023
March 21-22, 2023
May 2-3, 2023
June 13-14, 2023
July 25-26, 2023
September 19-20, 2023
October/November 31-1, 2023
December 12-13, 2023
Read our analysis of the previous Fed meeting:
There has been plenty of debate as to whether the U.S. has entered a recession. Real GDP (gross domestic product) declined in the first and second quarters of 2022, which would qualify for one definition of a recession. The stock market has dropped considerably, too. On the other hand, unemployment has remained quite low as employers struggle to fill jobs, and the economy is still growing.
Regardless of whether current conditions meet the definition of a recession, the Fed’s ongoing monetary tightening could cause recessionary conditions. Federal Reserve Chair Jerome Powell acknowledged the possibility of economic contraction and significant job losses.
“We have always understood that restoring price stability while achieving a relatively modest increase in unemployment and a ‘soft landing’ would be very challenging,” said Powell. “We don’t know — no one knows — whether this process will lead to a recession or if so, how significant that recession would be.”
Later, Powell added that he thinks there’s “a very high likelihood that we’ll have a period of…below trend growth,” but argued that such a period, as well as increased unemployment, would be necessary to restore price stability.
In his opening statement, Powell noted the labor market was very tight, citing record low unemployment, a historically high number of job openings and elevated wage growth, as well as robust job growth.
But, as part of the overall economic picture, “the labor market continues to be out of balance with demand for workers substantially exceeding the supply of available workers.” As the Fed raises rates to help fight inflation, Powell admitted there will “very likely be some softening of labor market conditions.”
Economists have traditionally understood there to be an inverse correlation between inflation and unemployment: since inflation is high, unemployment is low. The Fed has emphasized a strong commitment to bringing inflation down to its 2% goal, and in order to do so, they realize that unemployment will necessarily rise — and people will lose their jobs.
As part of the September meeting, the Fed released its Summary of Economic Projections (SEP), a quarterly set of predictions for the federal funds rate, real GDP, unemployment and Personal Consumption Expenditure (PCE) inflation over the next few years.
Unsurprisingly, the FOMC has revised inflation and federal funds rate expectations upwards again. Here are the committee members’ average projection for where the federal funds rate will land at the end of the following years, compared with their previous projections from the June SEP:
Here are the same projections for PCE inflation:
Longer run expectations have not changed. Inflation has been more persistent than expected, and the Fed has wanted to take an aggressive approach to rate hikes. According to the SEP, the public should expect the FOMC to raise the federal funds rate by an additional 1.00% or 1.25% over the last two meetings of the year. The next Fed meeting on Nov. 1-2 will shed more light on where the rate will settle before 2023.