As Federal Reserve officials gather in Washington on Tuesday to start a two-day meeting on setting monetary policy, investors see very low odds that they will raise their interest rate target. A “hold” on interest rates would ensure that it would be at least a year in between increases.
In opting not to raise rates for so long, keeping rates near zero even as the economy picks up, the Fed risks criticism.
Republicans already have raised concerns about the years of ultra-low interest rates. Donald Trump last week accused Fed Chairwoman Janet Yellen of keep rates low to aid Democrats in the November elections at the expense of the economy. House Speaker Paul Ryan warned on Monday in New York that the nation’s tax-and-spending policies were on a “collision course” with the Fed’s low-rate plans. Congressional Republicans have advanced legislation that would make the Fed’s interest rate decisions more accountable to lawmakers.
Some officials are on the same page and want to raise rates immediately. Others, however, see good reasons to wait longer. Here are four numbers weighing on the minds of those Fed members:
1. 0.8 percent, the inflation rate in July.
The most immediate reason not to tighten monetary policy is that, in the eyes of the Fed, inflation has been too low for a long time and it’s not clear that it will rise.
Fed officials generally see a trade-off between unemployment and inflation: Low inflation implies that unemployment could be even lower if the Fed boosted spending through low interest rates.
But inflation has been running below the Fed’s 2 percent target since October 2012 and actually fell in July, to 0.8 percent.
Furthermore, inflation expectations among consumers are near record lows, a cause of concern for Fed members because those expectations are what actually matters for people making plans about borrowing and buying or saving.
Fed governor Daniel Tarullo said earlier this month that “what is optimal right now is to look to see actual evidence that the inflation rate would continue to go up and to be sustained.” Without that evidence, low inflation basically entails that the Fed should be pursuing low rates, not raising them.
2. 2.1 percent, the expected annual rate of economic growth from private-sector forecasters.
In a speech at the end of August, Federal Reserve Bank of Chicago President Charles Evans floated the idea that there might be a new normal of slow growth, as reflected in Blue Chip forecasts of economic growth.
Slow economic growth in the future means that there is less value in investing in the future now, implying low interest rates. Talking to traders and investors, Evans concluded that the market might be setting low interest rates because of the prospect of permanently weaker economic growth.
3. 18 percent, the appreciation of the dollar since mid-2014, relative to a basket of major currencies.
The dollar has strengthened massively as the U.S. economy and the world economy have gone in different directions. As the U.S. has slowly made a comeback toward full health and the Fed has planned to raise rates, prospects have dimmed in Europe and Asia, and central banks there have moved to ease money.
The upshot has been a stronger dollar. A stronger dollar has many of the same effects as the Fed raising interest rates, by lowering the prices of imported goods and holding down prices, while hurting U.S. manufacturers.
Fed officials, in recent months, have suggested that foreign developments play an increasingly large role in the U.S. economy and in the demand for money, which they have to factor into their guesses about what “right” short-term interest rates should be.
4. 0.4 percent, the short-term interest rate targeted by the Fed.
Since December, the Fed has targeted an overnight interest rate of just 0.25 percent to 0.5 percent, and markets have recently set an actual rate of 0.4 percent.
Fed officials believe that market demand for dollars, driven partly by fears about overseas growth and partly by skepticism about future growth, means that such a low rate is appropriate for now.
But at so close to zero, there isn’t much room to cut that rate to react to a negative economic shock.
In years past, the Fed would react to recessions by cutting the short-term interest rate target by an average of 5.5 percentage points. Usually, doing so was effective in stabilizing the economy.
But obviously, it’s trickier to do so when you’re starting at 0.4 percent, or even at 3 percent, which is as high as Fed officials see the rate rising in the next three years.
In an August speech at a conference at Jackson Hole, Wyo., Yellen argued that the Fed would still be able to deliver stimulus even if it were forced again to lower rates to zero, by relying on tools such as quantitative easing.
But other Fed members have noted that those tools haven’t proved that effective and emphasized that it would be better to risk overheating the economy by waiting too long to raise rates than to face a deflationary recession with the short-term interest rate target already historically low.
That logic was one of the reasons that raising rates this month seems “less compelling,” Governor Lael Brainard said this month.
