Since the mild 2001 recession, the Federal Reserve has followed a policy of micromanaging the fed funds rate, as described in " 21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19," by Fed Chair Ben S. Bernanke.
Although Nobel-prize winning author Bernanke writes with confidence, it’s clear from the fed funds record that the Fed did a spectacularly bad job of stabilizing the economy. They kept the fed funds rate too low, addicting the markets to free money and causing asset bubbles to form. When they tried to normalize rates in 2005 - 2007 the result was the 2008 financial crisis. For the past 20 years, the Fed has cut the fed funds rate suddenly and extremely, going quickly back to zero.
The current Fed seems to realize that this whipsaw effect isn’t good for the economy or the asset markets. Having apparently achieved a soft landing, they are planning to gradually taper the fed funds rate in 2024-2026, according to the dot plot. They plan for a fed funds rate of 5% in 2024 and a longer-range fed funds rate of 2.5%, only slightly above their expected core PCE inflation rate of 2.0%. They do not anticipate bringing the fed funds rate to zero.
I would certainly be relieved to see the Fed acting gradually rather than whipsawing. Will this be possible?
By James Mackintosh, The Wall Street Journal, Sept. 22, 2023
The Federal Reserve is hoping for something it has never managed before: not merely the softest of soft landings for the economy, but the slowest rate-cutting cycle in its history…
Investors focused on the prediction that rates will come down less than previously expected, pushing up bond yields and hurting Big Tech stocks. But markets accepted the Fed’s prediction at face value. It will cut rates next year less than investors hoped, but then spread rate reductions over another three years, as inflation decelerates despite little in the way of job losses…
Work by International Monetary Fund economists published earlier this month found that successfully resolving inflation shocks in the past required tight monetary policy that lasted, taking an average of three years. Across more than 100 inflation shocks around the world, failure to deal with inflation was most often because of what the paper’s authors call “premature celebrations,” when inflation fell back and central banks relaxed policy…[end quote]
Fed Chair Powell is determined to stay the course on inflation, much like Fed Chair Paul Volcker did in 1980. Barring a true crisis situation, Powell will stay the course. Even if a recession occurs.
Hopefully, there will never again be the kind of crisis that would cause the fed to cut the fed funds rate to zero. Of course, “never” is a long time. And there’s no telling what a future Open Market Committee will do, given the example of decades of zero rates.