There are two explanations, one political, one economic, for the Fed’s decision to leave interest rates alone. The first of course, is that Fed chair Janet Yellen is a political animal, and the forces on her side have been agitating loudly to leave rates alone. History has shown that the Fed finds it easier to raise rates shortly after elections than shortly before them, and with the next one scarcely a year out reverting to a dovish stance is understandable.
But the economic issue that supports the Fed’s inaction is that it has adopted an inflation target of 2 percent, and it’s nowhere near that rate at the moment. In fact, recent measures have shown that it has been receding of late.
While I don’t put much stock in the dangers of a slight deflation, and consider the idea that a little inflation “greases the skids” of the economy a notion unsupported by theory or evidence, a commitment ought to be a commitment, especially when it comes from the Federal Reserve. And inflation targeting is not a Democratic idea by any means: Rep. Jim Saxton, chairman of the Congressional Joint Economic Committee through much of the 2000s, did a lot of inglorious work on this idea, and helped give it mainstream acceptance in Capitol Hill.
So, what does the failure to boost the discount rate mean for the next meeting? I think the implication is that until the Fed’s preferred measures of inflation start going up, Yellen will conclude that she must leave the rate where it is. The danger of such a stance is not that inflation may suddenly and without warning rise up and catch us unawares, but that the next recession occurs when rates are still low, and the Fed finds itself with fewer tools at its disposal to counter it.
Ike Brannon, an economist, is the president of Capital Policy Analytics.
