Chicago Fed: Current U.S. Interest Rates Adequate to Combat Inflation and Avert Economic Downturn

In a notable turn of events, risk assets, including the volatile world of cryptocurrencies, may be on the brink of what some are calling a “Goldilocks moment.” Recent research conducted by economists at the Federal Reserve Bank of Chicago has indicated that the U.S. central bank’s strategy of raising interest rates has been effective in curbing inflation, bringing it closer to the coveted 2% target, all without triggering a recession.

The findings, featured in the September edition of the Chicago Fed Letter, authored by Stefania D’Amico and Thomas King, are based on their vector autoregression (VAR) model. According to their analysis, the cumulative 500 basis points of interest rate increases implemented since March 2022 have already made a significant impact on economic output. Consequently, the economists argue that further rate hikes may not be necessary to rein in rising prices. It’s worth noting that this previous tightening cycle played a role in the crypto market’s downturn last year.

D’Amico and King stated, “We estimate that although the majority of the effects on output and inflation have already occurred, the policy tightening that has already been implemented will exert further restraint in the quarters ahead, amounting to downward pressure of about 3 percentage points on the level of real gross domestic product (GDP) and 2.5 percentage points on the Consumer Price Index (CPI) level.” Importantly, they emphasized that this decline in inflation is expected to transpire without pushing the economy into a recession, as real GDP growth remains positive.

According to their model, the headline consumer price index is likely to dip below 2.3% by mid-2024, which, according to the economists, aligns with a 2% inflation rate as measured by the personal consumption expenditure (PCE) price index. This 2% target has been a long-standing benchmark for the Federal Reserve, in line with its mandate for maximum employment and price stability. Notably, D’Amico and King’s model does not signal an impending rate cut or liquidity easing measures from the central bank.

If these projections hold true, it would signify a “Goldilocks scenario” – an ideal situation for risk-taking in global financial markets. Ever since the Federal Reserve commenced its rate-raising efforts, there has been ongoing concern in financial markets that such tightening could disrupt the global economy and potentially trigger another financial crisis. However, the research findings from the Chicago Fed suggest a more balanced and favorable economic landscape on the horizon.

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