The Federal Reserve’s recent decision to lower its federal funds rate target marks a cautious step toward easing monetary policy, though too much caution raises concerns about an incoming recession, according to an economist at Florida Atlantic University.

The Federal Reserve’s recent decision to lower its federal funds rate target marks a cautious step toward easing monetary policy, though too much caution raises concerns about an incoming recession, according to an economist at Florida Atlantic University.

While the Fed wants inflation to fall further, there are risks if monetary policy becomes too tight. Should the Fed hold its federal funds rate target too high for too long, it could cause a recession.  

“With inflation now running below target, the risk of resurging inflation is much smaller, and the risk of recession is much larger,” said William Luther, Ph.D., associate professor of economics in the College of Business. “Now is the time to ease up. If the Fed neutralizes the stance of monetary policy quickly and completely, it may yet avoid a recession. If it delays, as Federal Open Market Committee members project, we may not be so lucky.”

The Personal Consumption Expenditures Price Index (PCEPI), the Fed’s preferred measure of inflation, grew at a continuously compounding annual rate of 2.2% over the last year. However, it has slowed considerably in the past few months. PCEPI inflation has averaged 1.9% over the last six months and 1.4% over the last three months. In August, it was just 1.1%.

Core inflation, which excludes volatile food and energy prices and is therefore thought to be a better predictor of future inflation, has also declined. Core PCEPI grew at a continuously compounding annual rate of 1.6% in August. It has averaged 2.4% over the last six months and 2% over the last three months.

Over the last year, Fed officials have been looking for evidence that inflation is moving sustainably toward the 2% target. According to Luther, the latest data show inflation has already returned to 2%.

“If anything, inflation appears to be somewhat below target today,” Luther said. “Although the Fed has successfully reduced inflation over the last two years, it seems reluctant to declare victory.”

Monetary policy is still tight today and is projected to remain tight through 2025. More cuts are projected for 2025, but not enough to return the stance of monetary policy to neutral, Luther said.

-FAU-