The Federal Reserve implemented a substantial interest rate cut on Wednesday, reducing its benchmark lending rate by half a percentage point, marking the first rate cut of this size since the early days of the COVID-19 pandemic.
Federal Reserve Chair Jerome Powell emphasized that the decision was made to keep the US economy in “good shape.” However, historical data offers a mixed outlook on whether the move will prevent economic challenges such as a recession, rising unemployment, or inflation.
Recession Risk: Mixed Track Record Historically, rate cuts often signal that the Fed expects worsening economic conditions. While the aim is to soften the impact of a slowdown, recessions have often followed rate cuts. Excluding the pandemic, the US economy has experienced six interest rate cutting cycles since 1990, with a recession occurring, on average, 18 months after the Fed began cutting rates. However, the timing varies widely, with some recessions starting almost immediately and others taking several years to unfold.
Unemployment: Likely to Increase Data suggests that unemployment tends to rise following interest rate cuts. In the six previous cycles since 1990, the unemployment rate increased by an average of 1.4 percentage points within a year of the Fed’s decision. While there have been exceptions, such as in 1995 when the unemployment rate remained stable, in most cases, joblessness rose after rate reductions. The economic slowdown caused by the COVID-19 pandemic led to a spike in unemployment after the Fed’s cuts in 2019.
Inflation: Uncertain Path Ahead The relationship between interest rate cuts and inflation is less predictable. Some previous cutting cycles have led to higher inflation, as seen in 1996 and 2007, while others have coincided with inflation cooling off. The Fed must carefully manage the risk that rate cuts could reignite inflation, which remains a concern among officials like Fed Governor Michelle Bowman. She voted for a smaller cut, warning that a larger reduction could unnecessarily stoke demand and drive up prices.
Future Policy Movements Federal Reserve officials, including Minneapolis Fed President Neel Kashkari and Atlanta Fed President Raphael Bostic, have indicated that future rate cuts may be smaller as the Fed adjusts its policy to strike a balance between inflation control and employment concerns. Market analysts expect more rate cuts over the next few months, with the possibility of further reductions at upcoming meetings in November and December.
While the Fed’s decision has helped restore investor confidence, some experts warn that the rate cut could overheat the economy, potentially leading to asset bubbles similar to those seen in the late 1990s. At the same time, others see the potential for continued market growth, with some predicting that the US stock market could reach new highs if economic conditions remain favorable.
