Business News/ Economy / What Grade Does the Fed Get for 2023?
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The past two years—2022 and 2023—will long be remembered as two of the most consequential years in monetary policy and macroeconomics.
The past two years—2022 and 2023—will long be remembered as two of the most consequential years in monetary policy and macroeconomics.
Few economists would have written this script ahead of time. The two years featured an unprecedented, aggressive tightening of monetary policy by the Federal Reserve. Starting at effectively 0%, the Federal Reserve raised the target federal-funds rate, the overnight rate that it controls most directly, to 5.25%-5.50% through its December meeting. The Fed raised its target for the federal funds at 11 meetings in 2022 and 2023, before pausing in the summer of 2023. For a Fed that normally moves in increments of 0.25%, this tightening cycle featured four extremely large 0.75% increases and two increases of 0.50%.
Few economists would have written this script ahead of time. The two years featured an unprecedented, aggressive tightening of monetary policy by the Federal Reserve. Starting at effectively 0%, the Federal Reserve raised the target federal-funds rate, the overnight rate that it controls most directly, to 5.25%-5.50% through its December meeting. The Fed raised its target for the federal funds at 11 meetings in 2022 and 2023, before pausing in the summer of 2023. For a Fed that normally moves in increments of 0.25%, this tightening cycle featured four extremely large 0.75% increases and two increases of 0.50%.
You only need to have a glancing knowledge of the economy to know how extraordinary all that is.
The need to take such unprecedented action was the result of a post-Covid spike in inflation, with the annual consumer-price index reaching a peak of 9.1% in June 2022.
To date, the Fed’s campaign has been successful in reducing inflation, but the job of taming inflation—returning it to the Fed’s 2% target—is far from complete. Annual CPI inflation has fallen from its high of 9.1% to 3.1% in November 2023, its most recent measurement. More important to the Fed itself, core inflation, measured without volatile food and energy components, was most recently 2.9%, down from its high of 5.47%.
As unknowable as this script could have been, in some ways, the unwritten script ahead for the Fed is even trickier. Market participants appear to believe that the Fed’s tightening campaign has ended, with rate cuts potentially starting in early 2024. In contrast, some Fed officials seem to believe that one more tightening move might be required; no Fed official seems willing to state definitively that the Fed has ended the tightening cycle.
The grade so far
If we were grading the Fed’s 2023 performance, the best I could give would be an “incomplete": too soon to celebrate victory but no reason to call it a defeat. The Fed regained some of the credibility many believe it had lost by being late in confronting the inflation challenge. However, inflation, while declining, remains stubbornly above the Fed’s 2% target.
Consequently, there are serious debates among policy makers and observers about the next step in the Fed’s battle. Hopes for a “soft landing" have increased, but the elusive goal of achieving a soft landing is still not assured. Financial markets, businesses and, most important, the American consumer, seem to have been able to withstand the Fed’s pivot to aggressive hikes reasonably well, but there are fissures evident in the housing, banking and manufacturing sectors. Some argue that the year’s spate of labor unrest has been exacerbated, if not caused, by both the buildup of inflation pressures and the Fed’s aggressive rate increases—both of which did the most direct damage to middle-income Americans.
So if the Fed’s grade is incomplete, the major theme as we enter 2024, for both the Fed and the economy, is “uncertainty."
Of course, the direction of the economy is always, to some extent, uncertain. But there is normal uncertainty and then there is the current uncertainty. They aren’t in the same universe.
For one thing, and central to business thinking, is that the cost of money—that is, interest rates—has likely moved from a pattern of “lower for longer" to “higher for longer," thanks to a return of inflationary pressure. Additionally, the past 30 years have been characterized by wars that were remote and unlikely to influence the global economy; now we are in a period when conflicts (hot and cold) are having a visible impact on the prices and availability of major resources. Finally, supply chains, which for the past few decades were optimized for efficiency, are now being optimized for security and resilience.
In short, the conditions under which most business leaders operated are being replaced by a new set of realities. And the result: extraordinary uncertainty.
The best target
Another uncertainty surrounds the Fed target itself. There are concerns that getting to the 2% inflation target could seriously harm the American economy, but stopping short will undermine the Fed’s credibility. The Fed can choose to stay the course or settle for inflation that is higher than its traditional target.
The Fed has adopted a policy of greater transparency, in part to reduce all this uncertainty. This includes both publishing the Federal Open Market Committee members’ expectations of future policy moves and a process of attempting to signal policy moves to the markets in advance of taking the move.
However, this year has shown the limits to this transparency. The Fed’s own expectations have proved inaccurate—the committee has raised rates higher than its members expected—and the Fed abandoned the practice of providing guidance. Consequently, the Fed itself has moved from being a source of certainty to a source of increased uncertainty.
Finally, the question of whether the Fed will reduce rates in 2024 is inextricably tied to the question of whether the economy will fall into recession next year. The economy proved to be resilient in the face of the Fed’s aggressive tightening of 2022-23. However, a recession is still a strong possibility—driven by a weakening consumer sector that will be buffeted by both higher interest rates and a declining cushion of household savings, as well as the potential fallout from either an internal financial shock, emanating from the interest-sensitive banking or housing sectors, or an external geopolitical shock, emanating from any number of global hot spots.
The degree of uncertainty with which we enter 2024, I believe, is weighing on households and businesses alike. In a recent survey of CEOs that I conducted for the Business Council and the Conference Board, CEOs continued to express pessimism about the outlook for the economy and their sectors.
Meantime, consumer confidence has also dipped, stemming from concerns about higher inflation, future job availability, rising interest rates, future income and personal finances.
The findings for both CEOs and consumers are surprising given the economy’s resilience. However, this is yet another result of the uncertain times we’re in. When fundamental questions of the direction of interest rates and the outlook for the economy are at the forefront of personal and business decision-making, planning becomes very difficult. And the cost of being wrong rises for both households and businesses.
In hindsight, the most important lesson of 2023 is one many people have had the luxury of forgetting in recent years—that inflation is a pernicious tax on all Americans and must be attacked immediately.
The causes of inflation are numerous and vary from period to period. However, the result of having inflation emerge is always the same. The Fed must administer a tough medicine of higher rates to drive inflation out of the system. This is widely recognized as a blunt tool—a tool that works indirectly and unpredictably, and inevitably creates uncertainty.
We are experiencing that uncertainty now. Uncertainty weighs on us all in making decisions—small and large, for families and businesses. A year from now, we should have a much clearer picture of where we are, and whether our individual decisions were wise ones. And we’ll know much better what final grade to give the Fed.
Roger W. Ferguson Jr. is a former vice chairman of the Federal Reserve, and a former president and chief executive officer of TIAA. He can be reached at reports@wsj.com.
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