Economists at the Chicago Fed suggest that the recent rate increases have successfully steered inflation towards the 2% target while maintaining a stable economy. They argue that further tightening may not be necessary, potentially creating a favorable environment for risk assets, including cryptocurrencies.
In the September edition of the Chicago Fed Letter, economists Stefania D’Amico and Thomas King present their findings using a vector autoregression (VAR) model. According to their analysis, the 500 basis points of rate hikes implemented since March 2022 have already had a significant impact on output, and additional increases may not be required to control prices. It is worth noting that the tightening cycle was partly responsible for the crypto market crash last year.
The economists estimate that the effects on output and inflation have largely materialized, but the tightening measures already in place will continue to exert restraint in the coming quarters. They anticipate a downward pressure of approximately 3 percentage points on real gross domestic product (GDP) and 2.5 percentage points on the Consumer Price Index (CPI) level. Importantly, they highlight that this abatement of inflation is expected to occur without triggering a recession, as positive real GDP growth is projected throughout the forecast period.
According to their model, the headline consumer price index is likely to decline below 2.3% by mid-2024, aligning with the Fed’s target of 2% inflation as measured by the personal consumption expenditure (PCE) price index. The economists do not anticipate rate cuts or significant liquidity easing in the near future.
A combination of declining inflation and a resilient economy would create a goldilocks scenario, which is conducive to risk-taking in global financial markets. Concerns have persisted that the tightening measures could disrupt the global economy and lead to another financial crisis. However, the forecast from D’Amico and King provides reassurance that the current trajectory is on track to achieve the desired inflation target.
While there are concerns of a potential rebound in headline CPI due to rising oil and food prices, the economists argue that the Fed’s persistent explicit forward guidance has influenced expectations and reduced the time for rate increases to impact inflation and the economy. They emphasize that the effects yet to come may still be significant enough to bring inflation closer to the target in a reasonable timeframe, highlighting the importance of managing expectations and the potential impact of monetary policy.
