In March 2022, the Federal Reserve began raising interest rates at an aggressive pace to fight rising inflation. Now, two years later and with inflation near the Federal Reserve’s target rate, the question on most of our minds is, will the Federal Reserve begin to bring interest rates down this year?
The Federal Reserve enacts monetary policy in the United States with the dual mandate of 1) keeping inflation low and stable and 2) maintaining full employment in the economy. To achieve these goals, the Federal Reserve’s main policy tool is to adjust the federal funds rate or the rate at which banks in the Federal Reserve System lend to one another overnight. This rate is set by the Federal Open Market Committee (FOMC), which meets eight times each year (roughly every six weeks) to determine if any change in the federal funds rate is warranted.
Figure 1 below shows how the federal funds rate has changed in comparison to the inflation rate, measured using the Personal Consumption Expenditure index (PCE), and the unemployment rate. From March 2022 until August 2023, the FOMC increased the federal funds rate every time they met. Since then, they have held interest rates steady between 5.25% and 5.50%.
Figure 2 below shows how increases in the federal funds rate have impacted the cost of borrowing. Since March 2022, the bank prime rate has increased from 3.25% to 8.50%. Rates for variable rate agricultural loans, as reported by the Federal Reserve Bank of Dallas Agricultural Survey, have followed a similar trend. Interest rates reported in the survey for the first quarter of 2024 were roughly 9.50% for operating loans, 9.27% for intermediate loans, and 8.88% for long-term farm real estate loans.
Whether or not the FOMC begins to ease interest rates this year will depend largely on whether the inflation rate continues to decline. As shown in Figure 1, the rate of overall inflation in February 2024 was 2.5%. The core inflation rate, which excludes food and energy expenditures, was slightly higher at 2.8%. The Federal Reserve’s target rate for inflation is 2.0%.
It seems clear from the figure that the FOMC’s aggressive rate increases have been successful in taming inflation; however, inflation remains above the Federal Reserve’s target rate. Perhaps more concerning, at least from the perspective of the FOMC, is that the rate at which inflation is decreasing has slowed over the past year. In fact, the inflation rate essentially remained unchanged from December 2023 through February 2024.
It is unlikely that the FOMC will bring interest rates down if inflation remains above the Federal Reserve’s target rate. However, FOMC members have given no indication that they intend to raise interest rates above their current levels to achieve that goal either. In the short term, the safe bet seems to be to expect interest rates to hold steady at or near where they are now. Two caveats to this prediction are unexpected changes in either the inflation rate or the level of employment in the U.S. economy. Should the inflation rate begin to move upward, the FOMC may decide they have no choice but to resume interest rate increases. Alternatively, signs that indicate the U.S. economy is entering a recession would pressure the FOMC to begin lowering interest rates despite greater-than-desired inflation.
According to the Federal Reserve’s description of its monetary policy goals, the Fed does not specify a numerical goal for employment like it does for inflation; therefore, it is difficult to predict what specific economic conditions would encourage the FOMC to ease interest rates prematurely. One employment indicator that the FOMC will pay attention to as it makes interest rate decisions is the unemployment rate. An unexpected increase in the unemployment rate could indicate that the economy is entering a recession.
The most recent estimate from the Bureau of Labor Statistics places the unemployment rate at 3.8%, which is below the 30-year average and in line with the long-term projections made by FOMC members. Furthermore, the unemployment rate has held steady at or near pre-pandemic levels even as interest rates have increased (Figure 1). Based on this data, it appears that high interest rates have had little impact on employment, at least up to this point. Should this continue, the chance that the FOMC will vote to decrease interest rates before they reach their inflation target is small.
Figure 1. Changes in the Inflation rate, the Federal Funds Rate, and the Unemployment Rate, January 2018-February 2024
Figure 2. Changes in the Federal Funds Rate, Bank Prime Rate, and Selected Agricultural Loan Rates, Q1 2018-Q1 2024
References
U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, April 5, 2024.
Board of Governors of the Federal Reserve System (US), Bank Prime Loan Rate Changes: Historical Dates of Changes and Rates [PRIME], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PRIME, March 27, 2024.
Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [FEDFUNDS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FEDFUNDS, April 1, 2024.
Board of Governors of the Federal Reserve System (US), Median Personal Consumption Expenditures Inflation, retrieved from the Federal Reserve Bank of Cleveland; https://www.clevelandfed.org/indicators-and-data/median-pce-inflation.
Board of Governors of the Federal Reserve System (US), Agricultural Survey, retrieved from the Federal Reserve Bank of Dallas; https://www.dallasfed.org/research/surveys/agsurvey/2024/ag2401#tab-report.
Board of Governors of the Federal Reserve System (US), Monetary Policy Principles and Practice, Monetary Policy: What Are Its Goals? How Does It Work. Retrieved from: https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm
Board of Governors of the Federal Reserve System (US), March 20, 2024: FOMC Projections Materials, Accessible Version. Retrieved from: https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20240320.htm
