Fed's rate hikes proved effective at controlling Inflation, researchers say

Rate Cut on Horizon: New studies now argue that it was more the Federal Reserve's decisive interest rate increases over the past two years, as fundamental factors for restoring its credibility and taming inflation. A study underlines that the public promises of the Fed played their role, but it was the real actions, in particular raising interest rates, that really sealed market confidence and raised the power of monetary policy.

The point is how much the financial markets' perception of the Fed being committed to controlling inflation determined the outcome of monetary policy. That perception was, as the authors find, hazy at first and then fixed—blurred at first and then fixed only after the Fed started hiking interest rates in March 2022 and kept doing so aggressively during the summer.

Before these rate rises, forecasters and markets remained in limbo regarding the response of the Fed to mounting inflation. In the view of the researchers, large interest rate hikes had to occur to shift these expectations and to clearly indicate that the Fed was targeting a 2% inflation rate. Before the clear influences of Fed actions were manifest, there was much uncertainty over both the objectives and business approach of the Fed.

From the study, it can be argued that mere verbal commitments have limitations in terms of power to achieve economic outcomes. Though there were plenty of speeches and public utterances of commitment to controlling inflation by the Fed officials, it was the real policy changes that got the markets convinced about the Fed's resolve. Fed credibility improved markedly after the Fed made bigger + 75bp hikes in rates and Fed Chair Powell's stern comments to stay the course and target the inflation problem at the 2022 Jackson Hole conference, even if that means leading to economic discomfort—paving the way for more:.

This is important, the researchers argue, for the reason that in the future, policy doubt can best be communicated to all through concrete action, more so if a monetary policy framework is elusive. They suggest that to further cement the public stay on the target commitments, the Fed's quarterly Summary of Economic Projections might have to be modified so that its response to economic conditions is more specific and actions taken that continue to reinforce the Fed's commitment to its inflation targets.