The Federal Reserve left the fed funds rate in the zero to 0.25% range at its March meeting. This is the 15th month that the Fed has maintained rates at an all-time low. At the conclusion of the meeting the Fed stated that it will keep rates near zero "for an extended period of time," so no rate increase should be expected for at least several more months. Examining how the Fed reacted to past recessions can provide investors with some insight into when the Fed will actually change to a more restrictive interest rate policy this time around.
According to the official record, the previous U.S. recession took place between March 2001 and November 2001. This recession was unique in that it is the only one in U.S. history where consumer spending didn't drop and it was also one of the mildest recessions on record. Fed funds bottomed at 1.00% in June 2003 - 19 months after the recession was supposedly over. The backdrop was very low inflation. News reports of a jobless recovery were common even in the fall of 2003 and there was great concern at the time because the unemployment rate was at the 6% level (as opposed to 10% today). Fed funds remained at a low point for 11 months, so the Fed started raising its funds rate 30 months after the recession officially ended. If we optimistically assume that the current recession ended in July 2009 because GDP turned positive in the third quarter of the year, this would imply Fed funds would start rising around January 2012.
The recession before the one in the early 2000s took place between July 1990 and March 1991. Fed funds bottomed at 3.00% in September 1992 - 18 months after the recession officially ended. Jobless recovery was also a big news item in 1993. Commentators noted that payroll employment in the 7 previous U.S. recessions had increased on average around 7% in the two-years following the business trough, but had barely budged in that time period after the 1990-1991 recession. The unemployment rate was around the 7% level. The backdrop was declining inflation. The Fed started raising rates in February 1994, so the low rate was maintained for 16 months and this was 35 months after the recession was declared to be over. This would imply that the Fed will start raising rates around June 2012.
The prior recessionary period was the double dip recession that took place between January 1980 to July 1980 and July 1981 to November 1982. This recession was actually created by Federal Reserve policy and sent the U.S. industrial base into a decline from which it has never recovered. Inflation was high and at its peak, so interest rates were at the start of a long-term decline. Fed chair Volcker kept raising Fed funds rates until they reached 20%. The last time that they were that high was October 1981. They were then lowered until they had fallen to 8.5% in December 1982. The funds rate was then raised until a new lowering cycle began in September 1984. The funds rate bottomed at 5.875% in August 1986. High fed funds rates did not cause our current recession, so this period of economic history is not necessarily relevant to today's situation. The recession did take place at the beginning of a multi-decade shift in interest rates and this is also occurring now, although we are at the bottom of the cycle and not at the top like we were in the early 1980s. Japan's experience since 1990 indicates that rates can remain at or near their low point for well over a decade.
Before our current recession, the worst post World War II recession occurred between November 1973 and March 1975. Inflation was high and rising during this time period, so interest rates were generally trending upward. Unemployment peaked at 9.0% in May 1975. The concept of a jobless recovery was an unknown phenomenon. The Fed funds rate reached a low of 4.75% in January and November 1976. The Fed started a consistently more restrictive interest rate policy 21 months after the recession ended. That would imply that April 2011 could be the first Fed funds rate increase this time around.
Historical examination indicates that when the Fed starts raising rates depends on when a recession occurs in the context of a longer-term inflationary/deflationary cycle. When the inflation rate has already been falling for a decade or more or is around its low point, it takes longer for a rate rise than it does in a rising inflationary environment. Two to three years after a U.S. recession has been declared officially ended seems to be the norm before a tighter interest rate environment begins regardless of the inflationary backdrop. If the Fed raises rates on the short side of this number, this will indicate we are heading into rapidly increasing inflation. If it takes more than three years, it will indicate the possibility of grinding deflation as has occurred in Japan since the 1990s. The first alternative is the proverbial devil and the second is the deep blue sea.
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