Modern History of Surprise Rate Cuts: Do They Actually Work?

2007 to 2008 Financial Crisis

Less than two weeks after the official August 2, 2007, FOMC meeting announcement, the FOMC took action on August 17, 2007, by keeping fed funds flat at 5.25%, but it lowered the spread between the primary credit window and fed funds. The statement included the following:

These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained.

During the financial crisis, the Fed’s move to a zero interest rate policy (ZIRP) seemed unprecedented. There was a lot that happened before getting there. On January 22, 2008, the FOMC cut rates down to 3.50% from 4.25% in response to what had been rapidly declining economic conditions that began in 2007. The FOMC statement from January 22, 2008, said:

The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent. … The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets. … The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully. … Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

The FOMC again lowered interest rates by another half-point to 3.0% on January 30, 2008, and the Fed embarked on a total of seven rate cuts by the of 2008 for the fed funds rate to remain at the 0.00% to 0.25% range. Fed Chairman Ben Bernanke adopted ZIRP, the government wrote massive bailout checks to the banks and financial institutions, and the Fed started to greatly expand the Federal Reserve balance sheet. These lessons were against a backdrop that the Federal Reserve was very late to the party after the 1929 crash and that its lack of bold actions at the time allowed what could have been a routine recession to become the Great Depression that wiped out the 1930s.

The last surprise interest rate cut was on October 8, 2008, due to continued growing weakness and major pressure in the economy that became the financial crisis. Fed funds were taken to 1.50% from 2.00% prior to the zero-rate policy set in December of 2008. It would not be until December of 2015 that the first quarter-point rate hike would be seen under Fed Chairman Janet Yellen.

The 1994 Surprise Rate Hike

While surprise interest rate cuts have been made, it is much rarer for “emergency” rate hikes to be seen. That did occur back in April of 1994, after rates had already started to be hiked that year. That was when rates went up to 3.75% from 3.50% and fed funds went up to a high of 6.0%, after being hiked on February 1, 1995, to be followed by the first quarter-point rate cut almost exactly six months later.

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