Will Federal Reserve Rate Hikes Pull Down Inflation? Probably Not, New Research Shows

We all know inflation is bad right now. But will the Federal Reserve’s actions have any helpful consequences?

Probably not, new research shows.

“The prevailing view that rate hikes are causative in curbing inflation implies a negative correlation between the two variables,” writes David Ranson, director of research at financial analytics firm HCWE & Co.

Or put another way, if the Fed’s policy of raising interest rates works, we should see falling inflation in the months after rate hikes get announced. It should also work vice-versa with inflation rising after rate cuts.

Unfortunately for the Fed’s analytical economists, that doesn’t appear to be the case, Ranson shows. And with the November-dated 7.1% inflation reading, that should worry everyone with a dollar or two in the bank.

Here’s what you need to know.

First, rate hikes are generally positively correlated with the current level of inflation. That’s normal. Based on the Fed’s policies you’d hardly expect the policy team to raise them when there wasn’t inflation problem.

However, it the next finding that is both intriguing and worrying.

“U.S. history plainly shows a positive correlation, […] Rates movements are [also] positively related to the following year’s inflation.” Ranson emphasis.

He tracks inflation using the producer price index which tends to be more sensitive that the more standard consumer price index.

Ranson conducted his study using data going back tot he 1955, and did a separate study using monthly data back to 1954. The results were the same.

“[The data] shows no sign that changes in the Fed’s target interest rate affect inflation in the expected way,” Ranson writes. “If anything, a rate hike is consistently followed by more inflation than rate cut.”

Put bluntly, the data doesn’t support the idea behind the Fed’s recent interest rate hikes.

Before jumping on the idea that when Paul Volcker ran the Fed and crushed inflation in the early 1980s, its worth considering the role that the gold market plays.

Ranson points to the fact that gold is generally sensitive to future inflation. In the case of 1980, gold prices were falling before any action was taken by the Fed. He explains as follows:

• “It [gold prices] famously peaked above $800/ oz in February of 1980, and thereupon began a dramatic decline. This occurred before chairman Volcker pushed interest rates to their high point, which was reached in August 1981.”

Again, the falling inflation rate in the early 1980s coincided with rate hikes. But those interest rate increases weren’t necessarily the cause of the fall in inflation.