One US Fed model suggests central bank has already beaten inflation

THE US Federal Reserve’s 5.25 percentage points of interest-rate increases over the past 18 months may be enough to bring inflation down to the US central bank’s 2 per cent target and avoid a recession, according to an analysis from two Chicago Fed economists.

“According to the model’s forecast, the policy tightening that’s already been done is sufficient to bring inflation back near the Fed’s target by the middle of 2024 while avoiding a recession,” Stefania D’Amico and Thomas King wrote in a letter published on Wednesday (Sep 6) on the Chicago Fed’s website.

The rate hikes the Fed has delivered over the past year-and-a-half have already helped slow inflation from the four-decade high reached in June 2022, according to the analysis. The economists found that about two-thirds of the tightening to date has already made its way into growth, while about 75 per cent of it has fed through to the consumer price index.

While policymakers say their benchmark interest rate is close to its peak for this tightening cycle, they’ve been grappling with whether more hikes might be needed to fully bring inflation down to their 2 per cent target. They’ve also been confounded by a post-pandemic economy that has shown remarkable resilience even as they’ve raised their benchmark rate to a 22-year high.

The new economic landscape has led some to wonder whether the lags with which Fed rate hikes are transmitted to the rest of the economy – historically thought to take as long as 18 months or two years – may be shorter now. D’Amico and King found that policy shocks were felt more powerfully at the beginning of this tightening cycle, so the largest effects may have dissipated already.

“However, a strong expectations channel also means a more powerful monetary policy, so the estimated effects not only occur faster but also are bigger than typically estimated,” they wrote. “This implies that the effects that are yet to come may still be big enough to bring inflation near target reasonably quickly.” BLOOMBERG