So we finally got a rate cut — and a supersized one at that.
After the move was announced Wednesday, Federal Reserve Chair Jerome Powell said officials made that decision to keep the US economy in its current “good shape.”
Will that pan out? Only time will tell, of course, but recent history doesn’t make it look like it’s a sure shot by any means.
Here’s a look at what could happen to the economy in terms of the labor market, inflation and the likelihood of a recession now that the Fed has lowered its sky-high benchmark lending rate.
Recession track record: mixed
Oftentimes, the Fed cuts interest rates because it expects economic conditions will worsen drastically in the near future and it wants to preemptively soften the blow, knowing it sometimes can’t prevent a recession altogether.
So in that regard, it shouldn’t be too shocking that recessions frequently begin after the Fed cuts rates.
Excluding the rate cuts that happened during the pandemic, the Fed has had six cutting cycles since 1990. Starting from the point that the Fed began cutting, the economy has fallen into a recession 18 months later on average.
But it’s a wide range: For instance, after the Fed began lowering rates in July 1995, it took 69 months for a recession to occur. However, a recession started immediately when the Fed cut rates in July 1990 and just two months after it cut in January 2001.
But it’s certainly not a comforting sign that one recession indicator is currently flashing.
Unemployment rate: generally rises
On average, for those six cycles, the unemployment rate rose by 1.4 percentage points a year after the Fed cut rates.
But had it not been for the pandemic that occurred less than a year after the Fed cut rates in August 2019, the unemployment rate likely wouldn’t have sprung up by nearly five percentage points by August 2020.
For instance, a year after the Fed cut rates in July 1995, the unemployment rate was unchanged at 5.5%. And the unemployment rate was actually lower in September 1999 compared to September 1998, when the Fed began a cutting cycle.
In the other four instances, the unemployment rate was at least a percentage point higher a year after the Fed cut rates.
Inflation: no clear trend
The Fed is currently playing risk manager. As it looks to keep the economy in good standing, a growing concern is whether cutting rates will cause inflation to spike.
Fed Governor Michelle Bowman, who voted for a smaller quarter-point cut as opposed to the half-point cut other officials voted for, said in a statement Friday that she was concerned the larger cut could “unnecessarily” stoke demand, potentially ushering in more inflation.
The concerns are valid, based on past cutting cycles. For instance, after the Fed cut in 1996 and 2007, the annual pace of inflation, as measured by the Consumer Price Index, rose by over a percentage point a year later. But in some cases, the Fed actually lowers rates in order to allow inflation to accelerate if prices are rising too slowly because consumers may be putting off purchases.
But in several other instances, inflation cooled significantly. Part of the reason for that is that the unemployment rate generally rose when inflation cooled. That’s because when consumers are unemployed, they tend to cut back on spending, which means businesses can’t pass along higher prices.
