The Fed now has an explicit dual mandate (low inflation and full employment). What if we assumed that de facto it has always had a dual mandate, and typically gives a 50% weight to each goal. We can then construct a policy index which measures deviations from their inflation target (2% for the core PCE deflator say) and employment target (deviation of the unemployment rate from the CBO estimate of the NAIRU say). Adding the two together (with the unemployment deviation inverted) will give us a range of readings which go from very hawkish to very dovish.
Assuming the Fed acts like a good bean counter, one can backfill the history of the Federal Funds rate in the light of this stylised policy index. (And examine variants of their policy goal or assume different weights for the two targets depending on the orthodoxy of the time).
The result of this exercise are shown below:
First we show the Federal funds rate back to 1960 With US recessions marked. Next we show the policy index with recessions marked. And finally we show the FF rate vs the policy index consensus forecasts and again with a mild recession forecast.
The typical lag between a peak in the policy index and the end of Fed rate hikes is 2-6 months. The policy index looks to have peaked back in February of this year.
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