Fed Research Suggests Policies Far Tougher Than Rates Only Suggest

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(Bloomberg) — A study by the San Francisco Fed found that U.S. monetary policy is likely to be much tighter than interest rates alone suggest, according to an updated calculation of a proxy measure that takes into account the outlook and balance sheet .

Financial conditions implied that the Fed’s key rate was above 5.25% in September, compared to its actual target range of 3% to 3.25%, according to analysis published Monday in the San Francisco Fed’s weekly economic letter.

“The proxy measure suggests that monetary policy has recently been significantly tighter than just the Federal Funds rate would indicate,” wrote Jason Choi, Taeyoung Doh, Andrew Foerster and Zinnia Martinez, the study authors.

Policymakers have raised interest rates by 3.75 percentage points so far this year, the fastest rate since the early 1980s, as they try to curb the highest inflation rate in 40 years. Officials last week made a 75 basis point hike for the fourth time in a row, bringing the target for the federal funds benchmark rate to a range of 3.75% to 4%.

The authors’ calculation updates one from 2016 and takes into account the Fed’s balance sheet shrinking program and future guidelines for the policy’s path.

Officials are shrinking their holdings of government bonds and mortgage-backed securities at a rate of $1.1 trillion a year and have repeatedly explained that they expect to continue raising interest rates to restore price stability. While the Fed didn’t begin rate hikes from near-zero levels until March, their public comments about the need for policies that had started months earlier already had the proxy rate higher, the authors wrote.

Some Fed officials have begun to express concerns that the central bank may be acting too fast with rate hikes and risking plunge the economy into recession by tightening too much. When they raised interest rates last week, the statement from the Federal Open Market Committee, explaining the decision, said officials would “take into account the cumulative tightening of monetary policy” and that it is trading with delays.

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