As the Federal Open Market Committee meets Tuesday (Sept. 20) to hold its sixth meeting of 2016, the only thing certain is that no one is sure if policymakers will raise interest rates now, by the end of the year, or any time before a new president is elected to office.
At a gathering of central bankers at Jackson Hole, Wyo., in late August that was not an official FOMC meeting, Fed Chair Janet Yellen made the strongest case for raising near-term interest rates since the December meeting at the end of 2015.
“Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives,” Yellen said at the Aug. 26 FOMC symposium. “Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months. Of course, our decisions always depend on the degree to which incoming data.”
But instead of offering any assurance to U.S. and global markets, Yellen did not offer a specific timetable and left many economists and other fiscal policymakers across the U.S. scratching their heads.
“There appears to be more uncertainty than usual about whether or not the Fed will make another interest rate move at its September meeting (today),” said University of Arkansas at Little Rock (UALR) economist Michael Pakko. “In previous expansions, the Fed has moved deliberately to move interest rates to a more neutral stance, but in this case we’re now more than seven years into the recovery and interest rates are still near record lows.”
Pakko, chief economist and state economic forecaster at the Institute for Economic Advancement (IEA) at UALR, said even though the U.S. jobless rate is near the full-employment level at 4.9%, labor force participation still rates remain low. There also appears to be little emergent inflationary pressure, he said.
“The low inflation and signs of weakness in overall employment suggest caution in moving rates higher,” Pakko argued. “However, there are some good reasons to consider raising rates sooner rather than later. First, monetary policy is famously known to affect the economy with ‘long and variable lags.’”
The UALR economist said conventional wisdom has always been that once there is an upsurge in inflation, the Fed is already behind the curve in controlling it. In addition, some members of the FOMC have been suggesting that the long period of low rates has fueled speculative excesses in some financial markets, laying the ground work for trouble in the future.
“Perhaps more importantly, the extended period of monetary accommodation contributes to a perception that the economy still requires monetary life support,” Pakko said. “I fear that after this much time, the economy is slipping into a long-run low interest rate equilibrium. Low growth prospects, low inflation and low interest rates feed on one another in peoples’ expectations, creating a cycle of weakness.”
If there is any consensus, the general feeling is that the Fed’s will raise interest rates before the end of the year. Besides the September meeting, the FOMC policymakers also will meet again on Nov. 1-2 and Dec. 13-14.
THE ‘NEW NORMAL’
In 2015, the FOMC waited until the lasting meeting of the year to announce a small rate hike from 0.25% to 0.5%. The move ended almost seven years of a near-zero percent rate and was the first rate hike in more than nine years. Yellen and other Fed members have since maintained an accommodative view on key interest rates, with an occasional attempt to challenge that policy in the six meetings between the last rate hike.
At the April meeting, Esther George, president and CEO of the Federal Reserve Bank in Kansas City, decided to challenge the policy, saying she preferred to raise the target range for the federal funds rate to 0.5% to 0.75%. Fed Vice Chairman William Dudley, St. Louis Fed President James Bullard and the other members of the FOMC voted with Yellen to hold interest rates steady.
Earlier this month, Federal Reserve Gov. Lael Brainerd, described the FOMC’s monetary policy as the “new normal,” saying she and other policymakers will continue to assess what policy will best promote the sustained attainment of the nation’s economic goals. Brainerd said the relationship between unemployment and inflation, known as the Phillips curve, is no longer a reliable guidepost for monetary policy.
“In particular, to the extent that the effect on inflation of further gradual tightening in labor market conditions is likely to be moderate and gradual, the case to tighten policy preemptively is less compelling,” she said.
The Chicago Fed governor also said a new normal must also recognize that global markets matter, labor market slack has been greater than anticipated, and neutral interest rates are likely to remain low for some time.
“In today’s new normal, the costs to the economy of greater-than-expected strength in demand are likely to be lower than the costs of significant unexpected weakness,” said Brainerd, who joined the FOMC in 2014. “In the case of unexpected strength, we have well-tried and tested tools and ample policy space in which to react.”
After the two-day FOMC meeting ends on Wednesday afternoon, the FOMC will announce it’s the results of its meeting, release its yearly forecast and Yellen will hold a press conference to discuss U.S. fiscal policy.