COTW: Cumulative Monetary Tightening Per Cycle

December 3, 2018

The chart below can be downloaded here


This week's chart shows the cumulative change in the Fed Funds rate for each U.S. economic cycle since 1954. This is a visual representation of the investor's mantra, "Don't Fight the Fed ".  Tighter monetary policy has been a contributing factor - and arguably the contributing factor - to the end of every sustained economic expansion in the last half century. The chart also shows the ultimate crisis or headline-grabbing bankruptcy that punctuated the end of each cycle of expansion.


The degree of tightening necessary to constrain economic activity varies from cycle to cycle.  Rates of growth, inflation and the contribution of credit to the then-current cycle all play a role, but the average for the last 50 years is about 400 basis points.  With just eight hikes so far this cycle, it would seem we have still have plenty of room for the Fed to hike.


However, this cycle had something unusual that we haven't seen in the last half century: quantitative easing. Rather than present the current effective Fed Funds rate of 2.2% as the roughly 210 basis difference between the low of this cycle and the current rate, we have adjusted the degree of tightening to factor in quantitative easing. In many respects, quantitative easing had the same effect on the economy as a deeply negative Fed Funds rate.  The effective or "shadow" Fed Funds rate which adjusts for quantitative easing was calculated by two University of Chicago PhDs.  Their methodology is explained here.  Incorporating this adjustment, it seems that the current degree of tightening is well beyond the level that has created issues for the economy in previous cycles.




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