The Federal Reserve’s plans for lifting short-term interest rates from zero for the first time since the 2008 financial crisis have hit a setback: inflation.
After heading toward the Fed’s 2 percent goal in the summer, inflation has begun dropping during the fall, complicating Fed officials’ view of the economy’s progress. Chairwoman Janet Yellen and other Fed officials view below-target inflation as a sign that the economy still has some slack that can be addressed with monetary stimulus.
When inflation ticked up over the summer, “some set of officials viewed that as the long-awaited uptick in the underlying rate of inflation,” said Lou Crandall, chief economist at Wrightson ICAP, noting that the rise in inflation then led some Fed members to consider raising interest rates as early as next spring. “That’s pretty much off the table at this point.”
Annual inflation stood at 1.7 percent in September, down from 2.1 percent in June, according to the Consumer Price Index released Wednesday by the Bureau of Labor Statistics. The slowdown has partly been driven by declining energy prices, especially oil. The price of a barrel of Brent crude oil fell to just above $80 Wednesday, down roughly a quarter since June and the lowest price since June 2012.
Bond market prices indicate that investors now expect the first rate increases to come in September 2015, although individual banks and investment managers project that rates will remain near zero into 2015. Those expectations reflected the Fed’s communications in recent months that its decision to raise rates will be based on inflation moving toward its 2 percent target, along with unemployment falling.
Only a few members at the Fed’s September meeting were concerned that inflation might not be moving toward the target, the minutes show. Some instead thought that accelerating job gains would translate into higher inflation in the months ahead. For her part, Yellen warned against reading too much into the “noise” surrounding inflation measures in June.
But the most recent inflation readings, along with increased volatility in stock and bond markets and a rapidly strengthening dollar, now might have more Fed officials worried about the possibility of disinflation over the medium term.
Noting that the “sluggish” inflation outlook would have the inflation forecast below 2 percent throughout 2015, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said in a speech last week that “it would be inappropriate for the [Fed monetary policy committee] to raise the target range for the fed funds rate at any such meeting” in 2015.
St. Louis Fed President James Bullard, not a voting member of the committee this year, even called for the Fed to postpone its plans to end its bond-buying program in October. “I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent,” Bullard said in an interview with Bloomberg. “And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December,” he added.
In particular, Bullard cited slowing inflation and sputtering economic growth in Europe as part of the cause for concern.
Slowing growth and deflation fears around the world haven’t just dragged down oil prices, but also have put downward pressure on a range of commodities and boosted the dollar, said University of California San Diego macroeconomist James Hamilton.
“An important factor in all of that has been news of a weakening global economy,” Hamilton said. He added that it “argues against tightening by the Fed if the world economy is on shakier ground than it seems to be six months ago.”
In the face of deflationary pressures from overseas, Hamilton said, the Fed shouldn’t count on the lowered unemployment rate to boost inflation, particularly in the face of other indications that suggest the labor market is weaker than the unemployment rate alone would suggest, such as the number of people forced into part-time work and the number of labor force dropouts.
“My inclination is, let’s wait to see some indication from inflation rather than just assume that there’s going to be the usual mechanical link that when unemployment gets to this level or lower we might start to see inflation go up,” Hamilton said, adding that “so far the evidence has all been for very low inflation, and as long as that’s the case I don’t see why the Fed needs to tighten.”
