The US Fed rates Story (1990-2023)

The U.S. Federal Reserve (Fed), often seen as the central banking bellwether for the world, has historically faced criticism for its responses to major economic downturns. Delving into relatively recent history helps shed light on whether the Fed has been overly reactive or if criticisms are just a product of hindsight.

The Dot-Com Bubble: A Prelude to the Housing Crisis?

At the turn of the 21st century, the implosion of the dot-com bubble wreaked havoc on the economy. The Fed's subsequent decisions set in motion a series of events that still dominate discussions among economists. Following the bubble’s burst, the Fed embarked on a rate-cutting spree, reaching a target rate of a mere 1%. This liquidity influx revitalized the economy, with GDP surging from +1.7% in 2001 to +3.9% in 2004.

However, this oversupply of cash presented an irresistible opportunity for banks and financial institutions, which began to lend profusely, often with scant regard for risk. Consequently, a burgeoning housing market emerged, fueled by easily accessible and cheap credit. By the time the Fed recognized the economy's overheating signs, they reversed course aggressively. Interest rates soared in a short span between January 2004 and September 2006. This rapid change and other economic factors precipitated the housing market crash. In response, the Fed made another sharp U-turn, slashing rates from 5.25% to almost zero.

The COVID-19 Era: A Déjà Vu?

The unprecedented challenges of the COVID-19 pandemic saw the Fed once again resort to drastic rate cuts, augmenting the money supply to an extraordinary extent. Some critics argue this was another overcompensation. But as the pandemic's immediate threats waned, the Fed retold its monetary policy.

Historical data indeed hints at a pattern: aggressive rate hikes by the Fed often precede recessions. This cycle of frenetic activity, sharp cuts followed by steep rises, invites scrutiny.

Reactive or Proactive: The Fed's Dilemma

One could argue that the Fed’s actions, particularly after the dot-com bubble, were boxed in by circumstances. Yet, the recurrent theme seems to be a pattern of strong reactive measures rather than proactive strategies. However, is it fair to lay the blame squarely at the Fed's doorstep?

In a recent FOMC statement, the Fed indicated its intention to maintain higher interest rates for a more extended period. While the future remains uncertain, history seems to caution against abrupt monetary shifts.

Conclusion

Decisions made in the throes of economic crises are invariably challenging. While the Fed's actions have occasionally been seen as overreactions, weighing them against prevailing global events is crucial. However, the cyclical nature of its responses, especially in terms of rate adjustments and quantitative easing, underscores the importance of proactive, forward-looking policies.

References:

https://www.statista.com/statistics/187616/effective-rate-of-us-federal-funds-monthly/

https://research.stlouisfed.org/

https://www.federalreserve.gov/monetarypolicy/fomc.htm

https://www.aeaweb.org/journals/jep