Is the Fed done raising interest rates?

Published November 16, 2023

By Michael Walden

Federal Reserve policymakers have been receiving much criticism in the last two years, ever since they began raising interest rates. Anyone taking out loans have seen what the higher rates can do to their loan payments. 

But could there be some relief on the horizon? Has the Federal Reserve (the “Fed”) signaled they are ready to stop increasing interest rates? And even better, is there a possibility that next year the Fed may begin lowering interest rates?

I’ll present the current thinking about the Fed’s plans, and then let you decide what the future path of interest rates may be.

But first, let me remind you why the Fed has been increasing interest rates. When Covid hit, the economy crashed, and the jobless rate jumped to 14%. The Fed went all-out to save the economy. No one knew how far Covid would spread and how long it would last. Paraphrasing the words of then Fed Chair Ben Bernanke during the sub-prime recession in the late 2000s, “we don’t want to wake up one day and not have an economy left.”

The Fed has two ways of influencing the economy. It can impact interest rates by moving an interest rate it directly controls. The Fed also has the power to change the supply of money in the economy.

During the pandemic, the Fed used these powers to the fullest. The Fed reduced its key interest rate effectively to zero, causing other interest rates to tumble. The Fed also increased the money supply by $6 trillion, largely by financing the federal debt issued to fund the Covid relief spending.

The economy began to strongly revive by the middle of 2020, and the recovery continued in the following years.  Economists are already debating whether the Fed overdid their help. One reason for this debate is what happened next – roaring inflation.

The Fed ignored inflation when it used its powers to stimulate the economy and promote job growth in 2020.  This is not unusual. Although the Fed’s mandate is to keep both inflation and unemployment low, it usually focuses only on one. The reason is simple. The policy prescriptions for lowering the inflation rate and lowering the unemployment rate are the exact opposite. To push unemployment down, the Fed runs wide-open, lowering interest rates and creating money. But to moderate inflation, the Fed does the opposite – raising interest rates and reducing the money supply.

Why was the Fed ignoring inflation in 2020? There are three answers. One, the Fed considered growing the economy and jobs more important. Two, there was little evidence of rising inflation in 2020. And third, the Fed thought the economy would recover in the same way it did after the subprime recession. Then, there was no jump in inflation, whereas the jobless rate remained persistently high. The Fed thought the problem after Covid would not be inflation, and instead would be unemployment.

The exact opposite occurred.  As we moved in to 2021, the jobless rate continued to drop, but the inflation rate soared. But the Fed waited an entire year – until early 2022 – before shifting policy to address inflation. There are still questions about the reason for the delay.The most logical answer is the Fed didn’t realize how long it would take to fix supply chains. The Fed’s stimulative policies of easy money and low interest rates combined with supply shortages were a perfect recipe for big price jumps.

The Fed’s about-face in 2022 was one of the fastest policy shifts in the agency’s history. In less than a year and a half, the Fed took their interest rate from zero to over 5%. They also cut over $2 trillion from the money supply.

With the supply chain largely fixed and the economy growing slower, price pressures have moderated. The year-over-year inflation rate has eased from over 9% to close to 3%. The Fed’s goal is 2%. Also, the economy has thus far avoided a recession. With the Fed’s rapid slamming of the brakes on the economy, a year ago most analysts expected a recession by now. 

Now let me turn to the future and address two questions. Is the Fed finished increasing interest rates, and if so, when might the Fed begin to cut rates?

The Fed has kept their key interest rate constant since May. Although the Fed is very careful about revealing their thinking, I think the Fed is pleased with the direction of the economy.  Specifically, they like the fact price increases have gotten smaller and the economy has not slid into a recession. And although the average household’s standard of living is still lower today than before the pandemic, workers’ earnings have begun to rise faster than prices.

So here are my current forecasts. I see no further Fed-induced interest rate hikes. This doesn’t mean interest rates can’t rise for other reasons, such as over fears about the extent and impact of the Middle East conflict. 

But I don’t see any reductions in the Fed’s key interest rate for a while – probably no sooner than in mid-2024. The Fed wants to make sure their “medicine” continues to work to move the annual inflation rate to 2%. But once the Fed is satisfied this is happening, I predict they will cut their key interest rate 2 percentage points by the end of 2024. This change will prompt other interest rates to drop.

Guessing the actions of the Federal Reserve is always tricky. But I think the evidence and signs are aligning to motivate the Fed to make some interest rate reductions by this time next year. So, is it time to celebrate or continue to be wary? You decide.

Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.