The Federal Reserve has landed a hot U.S. economy softly before. It has also helped usher in a recession and nearly doubled unemployment.
Which will be this time? Our current Fed captain hasn’t offered too many opinions about how we might land, but he’s sounded modestly optimistic at times this year.
“The economy can return to 2% inflation without a really significant downturn or a really big increase in unemployment,” Fed Chairman Jerome Powell said in early February. “Many, many forecasters would say it’s not the most likely outcome. I would say there’s a chance of it.”
Since then he hasn’t given us much more to work with. Tray tables up and heads between our knees? Or just enjoy the view from 30,000 feet?
Powell and the committee have seen several important data points – including slowing job growth and inflation – in recent days before this week’s committee meeting, but many say the Fed isn’t done and at least one more rate increase is in the offing.
So probably the best we can do right now is look at where hard and soft landings left our economy and our finances in the past.
What has driven the Fed to raise interest rates
Let’s look at three times when the Federal Reserve has raised interest rates to cool the economy with very different circumstances and, potentially, very different outcomes.
The Great Inflation: From the mid-60s to the early 1980s, inflation became entrenched as America left the gold standard, went through two oil price spikes and disco. Not even a Bee Gees melody, though, could ease the pain of Fed Chief Paul Volcker’s task of taming high, long-term inflation.
The soft landing: Among the many things economists say Fed Chief Alan Greenspan got right was the soft landing the Federal Reserve executed in the mid-1990s when the U.S. economy was humming – possibly a little too fast.
Post-pandemic: Powell and the Fed have a whole different set of challenging circumstances now. At its peak, we could only compare this era’s inflation to the Great Inflation’s while our economy – even with rapid rate increases – continues to add workers as if it’s headed for a soft landing.
How those Fed’s economic challenges compared
How rapidly the Fed raised rates in these cycles
These three cycles of fed funds increases were among the steepest of the past 50 years. The fed funds rate establishes the interest rate for bank-to-bank lending, which ultimately ripples throughout the country’s financing.
Then: The Fed squelched the Great Inflation over three years by raising the funds rate to 20% multiple times. Talk about turbulence: The rate fell from 20% in March 1980 to 8.5% in June and rocketed back to 20% in December. The Fed didn’t hit those heights in 1994, but still doubled rates over the course of a year.
Now: After years of low inflation and several years with the funds rate near zero, the 10 increases have been felt quickly in today’s economy, too.
What the Fed rate increases meant to credit card rates
The interest rates banks charge on their credit cards are tied to to the prime rate, which is tightly linked to the Fed funds rate.
Then: In the late ’70s and early ’80s, state laws largely prohibited credit card lenders from charging more than 18%. In the mid-90s, with the prime rate between 8% and 9%, credit card rates were 15.5% to 16%.
Now: As the prime rate has risen to 8.25%, the average credit card interest rate for a new credit card has risen from 14.6% in February 2022 to 24.2% last week, according to LendingTree. That’s raised monthly interest charges to $140 – about a $55 monthly increase – on the average American’s $6,965 credit card balance.
How rate increases affected home sales
Higher rates have an even greater impact on a monthly mortgage payment. In all three eras, prices held relatively steady, but the number of existing homes sold dropped off.
Then: In both cases, existing home sales fell as the Fed tightened credit and didn’t rebound until the Fed started cutting interest rates. In the early ’80s, that cut the number of homes sold in half. Home sales in the mid-90s slid 17%.
Now: Existing home sales fell for a year before a short-lived rebound in February. Powell has been stedfast in saying we shouldn’t expect a reduction in rates soon. Many economists and investors are predicting that the fed funds rates could increase another 0.25% during their July meeting, which concludes Wednesday.
That could continue the troubling direction of the housing market, which was weighed down by higher mortgage rates throughout 2022. Mortgage rates have actually fallen a bit in July since nearly reaching 7% this month.
That leaves new home owners facing steeper mortgage costs than they were last year.
The median U.S. home sold for about $450,000 in 2022, according to the Census Bureau. In the past year, Freddie Mac’s reported 30-year mortgage rates have risen from 3.6% to 6.78%, increasing the monthly payment on a $450,000 home by more than $700, according to a Bankrate calculator.
What’s next now?
“The labor market remains very tight,” Powell told reporters in his prepared statement after the Fed meeting in June. “While the jobs-to-workers gap has declined, labor demand still substantially exceeds the supply of available workers.”
That and other statements have sounded more early ’80s Fed than the mid-90s Fed.
Why it could be like the early ’80s: High inflation drove the Fed to its rate-change decisions. Inflation has slowed, but Powell and the Fed seem squarely focused on a potentially inflationary tight job market in which workers’ pay increased by 7% in 2022. Those increases have moderated this year.
Federal Reserve economists have projected that unemployment could rise from its current 3.5% to over 4% this year as a result of the rate increases. That could also tip the economy into a recession.
Why it could be like the mid-90s: The strength of the labor market could also be the reason we don’t dip into a recession. Amid high-profile tech layoffs, the economy keeps adding jobs – but more slowly. We’ll get a first look on Aug. 4 at how many new hires companies made in July.
