Kansas City Federal Reserve's annual conference in Jackson Hole, Wyoming, has put out a study that revealed how aggressive interest rate hikes were a crucial part of its battle against inflation over the past two years. According to Reuters, the study showed that the Fed gained its credibility and public trust through rate hikes as it proved to control US inflation the most.

This new study stands in contrast to what economists Michael Bauer of the San Francisco Fed, Carolin Pflueger at the University of Chicago, and Adi Sunderam at the Harvard Business School found to be the case. 

Initially, their study found that financial markets were not convinced what the central bank would do. Despite speeches and assurances by Fed Chairman Jerome Jerome Powell and other officials, the view that the US central bank would push back harder on inflation really only got going after it began raising its policy interest rate in March.

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Fed Rate Hikes in Helping US Inflation

"Substantial rate hikes were apparently necessary for perceptions to shift," the researchers noted. "The public did not fully understand the Fed's strategy and policy rule prior to liftoff." This shift in perception, particularly after the Fed accelerated its rate increases in mid-2022, made monetary policy more effective. 

This, per IMF, allowed the central bank to influence financial conditions faster and control inflation with less damage to the economy than might have occurred otherwise.

The findings serve as a cautionary tale for future central bankers who may rely too heavily on "talk therapy" - the power of influencing economic outcomes through verbal communication alone. 

The researchers emphasized that while public trust in the Fed's commitment to controlling inflation was ultimately earned, it required decisive action to back up the words. 

As the researchers concluded, "Policy rate actions contribute to, and may even be necessary for, the effectiveness of communication, particularly when uncertainty about the monetary policy framework is high." The study also suggested that future policymakers could benefit from making the Fed's response to inflation more explicit in its communications, ensuring that actions consistently align with public expectations.

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