Should the Fed raise their benchmark interest rate at their meeting later this month?
As of this morning, financial markets put the likelihood of a March rate hike of another 25 basis points at 77.5 percent. That’s about twice what it was a few weeks ago, but since then, many Fed heads have suggested such a hike is on the table for their meeting later this month.
So, in the words of The Clash, should they stay or should they go?
Reasons not to raise:
–The job market is closing in on full employment, but it’s not there yet; both the underemployment rate and the prime-age employment rate remain elevated (btw, if you thought today was jobs day, you’re off by a week; this happens sometimes in March, as Feb is a short month). While a small brake tap won’t derail existing momentum, raising the cost of borrowing certainly could slow the pace of job growth.
–While the recovery is about eight years old, which isn’t young for an expansion, middle- and low-wage workers have only recently started seeing real paycheck gains. By early 2015, the real blue-collar and non-managerial wage was back to its 2010 level and it has generally kept rising. The tighter the job market, the more these workers will gain.
–Moreover, there’s little evidence that wage growth is bleeding into price growth, so given how important these recent gains are to middle- and low-income working households, why chance slowing them down?
–The strong dollar, which pushes against inflation (by making imports cheaper) is doing the Fed’s work for them!
–Which raises the most salient reason for the Fed to keep their feet off the brakes: their core inflation gauge remains below their 2 percent target. Core PCE prices have accelerated, as have inflationary expectations, but it has been holding steady at around 1.7 percent, year-over-over. Given that their inflation target is symmetrical–meaning years of being below target should be followed by some time above target–a pre-emptive strike on price growth is unwarranted.
Reasons to raise:
–The Fed has to see around corners, and thus often moves before utilization constraints are fully bindng.
–The economic headwinds typically cited in favor of holding have somewhat dissapted. As Fed governor Brainard put it in a speech this week: “With full employment within reach, signs of progress on our inflation mandate, and a favorable shift in the balance of risks at home and abroad, it will likely be appropriate for the Committee to continue gradually removing monetary accommodation.” She sees positive movements in the recoveries of Europe, Japan, and China, and stresses rising measures of both actual and expected inflation here at home.
–The Fed may view the stock market rally as a bit overdone and want to take action against too much speculation. At the same time, as noted above, the market now expects a rate hike, so to not raise would signal that the Fed is less optimistic about the economy than many of its members have been saying lately in speeches. That could tank the rally, though I doubt the governors give a very heavy weight to that possibility.
–The job market, or more precisely, labor demand, is in a solid groove and won’t be slowed by a small hike.
–“Normalization” of the Fed funds rate is necessary to avoid the zero-lower-bound problem when the economy weakens.
Basically, the case for raising is that the funds rate is still very low, they’re close to meeting the full employment side of their mandate, and the US and global economies are in strong enough shape to handily absorb a small hike. The case against raising is why tap the brakes when risks are still asymmetric, meaning that the risk of weakening demand is greater than the risk of inflationary overheating?
I see both sides and think it’s a close call, but I’m still more moved by the risk asymmetry case for holding than the “it won’t hurt, so let’s take out a bit of insurance against missing our inflation mandate” case for raising.
So I would stay rather than go, though just to be clear, I don’t think that if they stay there will be trouble and if they go it will be double.