The typical monetary policy cycle Monetary policy cycles are episodes in which policy rates rise quickly from a minimum, or stable, level to reach a local maximum, before either being held at this level or declining again to a new minimum. Across our sample, central banks have tended to increase policy rates by around 20 basis points per month before holding rates at their cruising altitude for eight months and then cutting them by 38 basis points per month during the descent. At the start of the tightening cycles, inflation averaged 2.8%, GDP growth 5.9% and unemployment 6.6%. By the time of the first rate cut, inflation was, on average, even higher at 4.1%, while growth declined markedly, on average, to 2.8% (Table 1). This highlights an important take-away from our analysis: central banks have tended to begin easing the policy stance with inflation still relatively high, possibly driven by concerns about declining growth and financial stability risks. It turns out that successful policy cycles tend to be characterised by declining growth around the time of the first rate cut, followed by a strong economic recovery and declining inflation over the subsequent two years (Chart 1). In soft landing episodes, this growth slowdown paves the way for declining inflation. Hard landings, on the other hand, are characterised by rate cuts in the face of deep recessions, with almost no difference in inflation outcomes compared to soft landings. Table 1 Average macroeconomic conditions at the time of the first rate cut across monetary policy cycles of major central banks Sources: ECB staff calculations Latest observation: April 2024 Notes: The table shows the average number and pace of rate hikes and cuts across different episodes, as well as the average holding periods. It also shows the average real interest rate (policy rate � inflation), inflation, GDP growth, and unemployment at the start of the easing phase (first rate cut), as well as changes in long term inflation expectations from Consensus Economics between the start of the hiking cycle and the first rate cut. Inflation, GDP growth and unemployment are shown in year-on-year percentage changes, while changes in inflation expectations are shown in basis points. * The full sample includes all 48 monetary policy cycles across nine central banks since 1970. Chart 1 Inflation and growth over the policy cycle (year-on-year percentage change based on monthly data) Sources: ECB staff calculations Latest observation: April 2024 Notes: The charts show the average inflation and growth rates at three points in time across policy cycles: (i) that start of tightening, (ii) the start of easing, and (iii) two years after the start of easing. The chart distinguished between episodes in which inflation undershot the target, landing on target, or overshot the target two years after the start of easing, as well as between soft and hard landing episode, which are labelled on the horizontal axis. Shocks and crises: unsuccessful cycles Not all cycles were successful in bringing inflation back down to target. We define successful cycles as those in which inflation returns to target within two years of the start of the first rate cut. Based on this classification, central banks were successful in just under a third of cases, while in the remaining cases inflation either remained significantly above target two years after the start of policy easing or ended up undershooting the target. Supply shocks, such as the sudden oil price spikes of the 1970s, were among the most likely factors to cause monetary policy cycles to fail. In the face of supply shocks, central bankers hiked interest rates more quickly (23 basis points per month) than in other episodes. But they have also been forced to cut interest rates faster (42 basis points per month) and by more (510 basis points of cuts) as the economic costs mounted and the financial sector came under strain. Over 70% of supply shock cycles in our sample ended in either a recession or a financial crisis. As a result, policy rates fell substantially below their starting levels during these cycles. The average holding period has also been shorter, at around 7.5 months. The challenging macroeconomic environment created by supply shocks is reflected in the data. At the time of the first rate cut inflation typically averaged around 6.1% with growth around 2.1% and unemployment at 5.5%. There are three factors that generally differentiate successful policy cycles from unsuccessful ones (Chart 2). First, better inflation outcomes are correlated with more favourable starting conditions such as lower inflation and higher economic growth. Second, growth tends to be lower, both over the tightening and easing phases, in successful episodes compared to unsuccessful ones. And third, unsuccessful cycles are typically characterised by low, if not negative, real rates where inflation is higher than the interest rates. It is worth noting that four of the cycles in our sample ended with the start of the COVID-19 pandemic, which explains, for example, the steep decline in GDP growth soon after the first rate cut at time t=0. Chart 2 Comparing successful easing cycles with inflation undershoots and overshoots (percentage points for the policy rates, year-on-year percentage change for inflation and growth based on monthly data) Sources: ECB staff calculations Latest observation: April 2024 Notes: The charts show the evolution of policy rates, inflation, and GDP growth over successful, and unsuccessful cycles and in case of inflation undershoots. Successful episodes as defined as those that saw a return of inflation to target within 2 years of the start of the easing phase. Undershoots are defined as those episodes which saw inflation fall below the target, and finally, unsuccessful episodes are defined as those that saw inflation remain structurally above target. The horizontal axis shows the months since the start of the easing cycle (t=0 at first rate cut). GDP growth is converted to monthly by using the quarterly values for the month. Landing softly: successful cycles