How the Fed battled inflation in 2022

December 28, 2022 4:01 PM

Jerome Powell, chairman of the U.S. Federal Reserve, has said the economy can weather the Fed's aggressive monetary policy tightening, thanks in part to healthy bank capital cushions.

If 'transitory' was the defining term for the Federal Reserve's view of inflation in 2021, the key word for 2022 was 'expeditiously.'

The Fed's Federal Open Market Committee hiked interest rates during seven consecutive meetings this year between March and December, bringing its benchmark rate from 0.25% to 4.5%, the most rapid tightening campaign executed by the central bank since the 1980s.

Typically, the Fed only adjusts its interest rate by a quarter of a percentage point at a time. This year, six of its seven hikes were 50 basis points or more, including four straight 75-basis point jumps.

On four different occasions, Chair Jerome Powell used his post-meeting remarks to highlight the importance of the Fed "moving expeditiously" to temper demand and rein in inflation.

In its final meeting of the year, the FOMC let off the gas slightly, opting to increase by only half a percentage point, with Powell saying he expects fewer steep hikes would be necessary in the year ahead. Of course, he noted, that is subject to change depending on economic conditions.

What follows is a review of the actions taken by the FOMC at each of its final seven meetings of 2022.

March: the slow but steady approach

The Fed's initial plans for cooling the economy appear paltry in hindsight.

On March 16, following its second meeting of the year, the FOMC increased interest rates by 25 basis points. It was the first time the Fed increased interest rates since 2018.

At the time, the FOMC projected six more similarly sized hikes for a year-end rate of around 2%, which would have been 1 percentage point higher than the committee projected at the end of 2021.

After the meeting, Powell said the Fed had been signaling an increase for months and financial markets had already made the necessary adjustments, a factor that he said would speed up the tightening effect of the policy adjustment.

"The moves are already priced into the market for some months now so the clock is running and we'll see some of that in the second half of the year as well," Powell said.

May: an expeditious adjustment

With inflation continuing to run at 40-year, the FOMC implemented its first extra large hike of the year in May, raising its policy rate by 50 basis points.

The move was the first time the Fed raised rates during consecutive meetings since 2006 and the largest single increase since 2000. The Fed also rolled out a plan to begin shrinking its balance sheet by allowing Treasuries and mortgage-backed securities to mature without replacing them.

This meeting marked the introduction of the Fed's expeditious monetary tightening campaign.

"Inflation is much too high, and we understand the hardship it is causing, and we're moving expeditiously to bring it back down," Powell said. "We have both the tools we need and the resolve that it will take to restore price stability on behalf of American families and businesses."

Powell noted that future 50-basis point hikes could be necessary at subsequent meetings, but said larger increases were "not something the committee is actively considering."

June: an ‘unusually large’ adjustment

As price indices continued to trend in the wrong direction, the Fed took a drastic step during its June meeting. It increased its benchmark rate by three-quarters of a percentage point.

The hike was the largest seen since 1994. With a cumulative increase of 150 basis points in just three months, the move raised concerns in some economic circles about potential financial stability implications.

Esther George, president of the Federal Reserve Kansas City and a voting member on the FOMC in 2022, voted against the increase over concerns about how rapidly the Fed was moving.

"Policy changes affect the economy with a lag, and significant and abrupt changes can be unsettling to households and small businesses as they make necessary adjustments," George said in a written statement at the time. "It also has implications for the yield curve and traditional bank lending models,such as those prevalent among community banks."

Powell acknowledged that the hike was "an unusually large one" and said he did not expect such steep increases to become common. However, he added that he anticipated an adjustment of 50 or 75 basis points at the next month's meeting.

June also marked the beginning of the Fed's balance sheet reduction, in which it began allowing $47.5 billion of assets to roll off monthly. This was the Fed's first quantitative tightening since 2019.

July: staying the course at 75

The FOMC did, indeed, raise by an additional three-quarters of a percentage point during its next meeting.

With a target range of 2.25% to 2.5%, this hike pushed interest rates above the year-end rate projected in March and above the Fed's 2% long-run inflation target.

Despite being widely anticipated ahead of the meeting, the increase amplified concerns about financial stability, with some economists fearing the rapid change could lead to a credit event within a large financial institution or trigger a sovereign debt crisis in another part of the world.

Powell waved off these concerns, saying the U.S. economy was strong enough to absorb the shock of higher interest rates and banks were well positioned, too.

"For a financial stability perspective, you know, asset values are down, which in some—in some sense lowers vulnerabilities. It's when they're really high that you would worry that they're—that they're vulnerable to a fall, actually. Many asset values have come down. I think you've got a well-capitalized banking system. I think you have—households are generally in about as strong as financial shape as they've been in a very long time or perhaps ever given the money that's on people's balance sheets," Powell said. "So you have a pretty—from a financial stability standpoint, you have a pretty decent picture."

September: ‘purposefully’ adjusting

September brought yet another 75-basis point increase, bringing the Fed's interest rate to more than 3% for the first time since 2008.

Powell dropped "expeditiously" from his post-meeting statement, but noted that the FOMC was still taking decisive action to make monetary policy less accommodating.

"We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2 percent," he said.

A week after this latest hike, Fed Vice Chair Lael Brainard delivered a speech about how rising interest rates in the U.S. are impacting global monetary policy and how the ripples of financial instability elsewhere in the world could be felt here.

"The global environment of high inflation and rising interest rates highlights the importance of paying attention to financial stability considerations for monetary policy," Brainard said. "As monetary policy tightens globally to combat high inflation, it is important to consider how cross-border spillovers and spillbacks might interact with financial vulnerabilities."

September was also a noteworthy month for the Fed's balance sheet reduction, with the monthly runoff cap increasing to $95 billion. Powell noted that the efforts to shrink its holdings — which had ballooned to nearly $9 trillion during the pandemic — would likely require it to sell assets at some point rather than merely allow them to mature, but he said that would not happen anytime soon.

How the Fed handles its balance sheet reduction is a point of keen interest for banks, who rely on the central bank for liquidity.

November: fourth time’s a charm

Despite concerns from economists about the effects of monetary policy to date and pushback from lawmakers on Capitol Hill, the Fed implemented a fourth 75-basis point increase in November.

The hike pushed the Fed's target range up to 3.75% to 4%, its highest rates since January 2008.

In his prepared remarks, Powell again said the Fed was moving "purposefully" to make monetary policy sufficiently restrictive.

Powell also said the committee had succeeded in its effort to raise rates "expeditiously" but noted that it would be mindful of the cumulative tightening before implementing future increases, leaving the door open for a slower pace of adjustments "as soon as the next meeting or the one after that."

December: duration over speed

Finally, during its December meeting, the FOMC slowed its pace of monetary policy tightening slightly, raising rates by just half a percentage point.

Powell said the Fed wanted to see how the economy responded to the increase implemented thus far, noting that monetary adjustments play out on a lag in many parts of the economy. He added that 50 basis points is still a "historically large increase."

While further increase will likely be necessary — a survey of FOMC members indicates the Fed will reach a terminal rate above 5% sometime next year — Powell said how quickly the federal funds rate reaches its final destination is less important than how long it remains there.

"It's now not so important how fast we go, it's far more important to think [about] the ultimate level, and then, at a certain point, the question becomes, how long do we remain restrictive?" Powell said. "That will become the most important question. But, I would say the most important question is no longer speed."

Powell said that whatever the peak rate ends up being, the Fed is likely to remain there for "some time."