Take a look at the Federal Funds Effective Rate chart (below) to see if you find a recurring pattern:
Notice the ten official recessions (grey shaded areas) since 1955. From a purely visual perspective, it seems successive interest rate increases, leading to a rate spike, normally precede a recession. If true, how can this be explained?
It could be a coincidence. Even if rate hikes generally come before recessions, it could be nothing more than chance or fluke. Rates either increase, decrease, or stay the same. However, it would be quite the ongoing coincidence if there were no relationship between interest rates and recessions. It would mean interest rates don’t play a role in the boom/bust cycle and would also downplay the role the Fed has in influencing the economy.
If not a coincidence, it could be attributed to the Fed’s coordinated efforts to use their tools and expert forecasting abilities to anticipate the onset of economic downturn. Should this be true, the Federal Reserve executes its policies with nearly pin-point precision, increasing rates just before a recession. According to the chart, for the last 70 years they’ve been successfully predicting recessions, and have not been a contributing factor to them.
This would be absolutely incredible! It would mean the Fed’s rate hike to over 5% in 2006 to 2007 was made in anticipation of the recession and housing crisis that followed, while the Fed’s raise to over 2% during 2018 to 2019 was anticipatory of the 2020 recession attributed to COVID.
If central bank coordination sounds highly improbable, if not completely impossible, then causation could be the third explanation. Instead of inferring the Fed raises rates because they see trouble on the horizon, it could be said that the Fed’s rate increases help cause recessions. To believe the Fed saw a housing crisis looming is one thing, but to say they saw COVID coming as far back as 2018 is completely absurd. Of the three explanations mentioned, the idea that the Fed has been culpable in causing recessions would most closely align to Austrian Business Cycle Theory, which attributes credit expansion creating artificially low rates as the cause of the boom, with their reversals as the cause of the bust.
Expanding on changes to interest rates, consider the Fed’s holding of US Treasuries during the last two recessions. Notice how the reduction in treasuries began in 2018, and prior to that at the start of 2008, both corresponding to periods of recession.
Use of the Fed’s charts is not an exact science, as the term recession for example is based on arbitrary analysis done by statisticians. But the point is to illustrate the various interventions and how these lead to economic booms and busts. And while the Fed is not the sole contributing factor since commercial bank’s play a significant role in credit expansion, the Fed’s intervention is easy to highlight as it’s been catalogued for a very long time.
If there was no economic impact from changing rates or the money supply then there would be no reason to change either of them. The problem is that some may rationalize that the Fed intervenes to help the economy, miraculously knowing when disaster strikes before everyone else, versus the idea that it’s the Fed’s intervention causing stock market and housing bubbles, and the bursting of those bubbles.
When the next recession hits or when the next bubble pops, it will be interesting to listen to the narrative which follows. Over a decade ago, evil bankers caused a housing crash, while the last recession was due to COVID. The next economic downturn may be due to another COVID outbreak, but it could be due to countless other narratives. The only certainty is that the Fed will have an explanation for it, never acknowledging the detrimental effect of their manipulation of interest rates or changes to the money supply.
