U.S. Economy Cruising Despite Interest Rate Hikes

By: Don Mathews
August 16, 2023

An extraordinary economic performance is going all but unnoticed.  Consider the U.S. economy over the past 19 months.

In January 2022, the economy was behaving strangely.

The labor market recovery from the pandemic showed no signs of letting up.  While workers continued to return to the labor force at a brisk clip, employment continued to grow at an even brisker clip.  The unemployment rate was down to 4.0 percent.

Yet production was falling.  Real GDP fell at an annualized rate of 1.6 percent in the first quarter of 2022.

More problematic was inflation.  In January 2021, inflation, as measured by the consumer price index, ran at a slow and easy 1.4 percent annual rate.  By January 2022, it was running fast and hot at 7.6 percent.

In February 2022, Russia invaded Ukraine.  In March, China imposed the most drastic of its pandemic lockdowns.

Something else happened in March 2022.  The Federal Reserve started tightening.

As we all recall, the economy tanked in the initial months of the pandemic.  The prospect of a pandemic-severe recession tandem prompted the Fed to move, with great urgency, to boost the economy.  It did so the only way it can: it pumped money into the economy.  It did so, aggressively and persistently, through the rest of 2020 and all of 2021.   Other central banks around the world did much the same.

The aggressive monetary policy succeeded in preventing a severe recession.  The price of that success was inflation.  Inflation is ultimately a monetary phenomenon.  Pump gobs of money into an economy month after month for twenty months is as surefire a recipe for inflation as there is.

The only way to reduce inflation is to do the opposite of what causes inflation.  So, in March 2022, the Fed began attacking the inflation caused by its persistently aggressive expansionary policy with persistently aggressive contractionary policy.

Fed policy manifests itself in two obscure but key interest rates: the IORB (interest on reserve balances) rate and the fed funds rate.  The Fed tightens by pushing the two rates up.  The more it tightens, the higher they go.

Since March 16, 2022, the Fed has pushed the IORB rate up from 0.15 percent to 5.4 percent, and the fed funds rate range up from 0.0-0.25 percent to 5.25-5.5 percent.  That is full-throttle contractionary policy.

And how has the U.S. economy performed since March 2022?

Since slipping by 0.6 percent (annualized) in the second quarter of 2022, real GDP has increased in each of the last four quarters.  The increases have been solid, ranging from 2 percent to 3.2 percent.

Contributing to the real GDP growth of the last three quarters is a surge in private investment – meaning construction – in manufacturing, technology and green energy facilities.

The U.S. labor force has increased by 2.8 million, employment has increased by 2.9 million, and the unemployment rate has fallen from 3.6 percent to 3.5 percent.

Even more impressive – and more telling – are the labor force participation rates for people age 25 to 54 years.  The participation rate for all 25 to 54-year-olds is now 83.5 percent, the highest level since May 2002.  The participation rate for 25 to 54-year-old men is now 89.4 percent, the highest level since January 2020.

The labor force participation rate for 25 to 54-year-old women exceeded 77 percent for the first time ever this past February.  It has remained above 77 percent every month since.

Inflation, which peaked at 8.9 percent in June 2022, is now 3.3 percent.

Such a stellar performance in the teeth of such tight monetary policy is extraordinary.  

Reg Murphy Center