Clashing with the Fed: Should they stay or should they go?

March 3rd, 2017 at 9:21 am

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!


Source: Fred database

–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.

Source: BEA

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.

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5 comments in reply to "Clashing with the Fed: Should they stay or should they go?"

  1. rjs says:

    just another reason to stand pat: negative GDP growth in January…

    real PCE came in at -.0.3, the worst since 2009, real construction spening was -1.3% (-1.0% nominal and 0.3% PPI construction inflation), and the goods trade deficit was near a nine year high…

  2. Smith says:

    This is the trouble with liberal Democratic economists. Everything they say is wrong.
    1) We are not near full employment.
    2) The 2% inflation target is a fundamentally wrong and misguided goal or policy makers.
    3) The whole idea of controlling inflation through wages suppressed by unemployment is ridiculous, illogical, and inefficient, and partially self-defeating.

    The fact that our friends, the liberal Democrats, promote these untruths, unsubstantiated, uncorroborated, myths, shows just how little hope the country has of obtaining anything like a viable economy that benefits the majority of workers, and redresses many of the inequities that are built into the current system.

    Evidence (from Factville as this blog likes to say) to support these arguments.

    1. U6, (underemployment, people wanting jobs but working part time, people not listed as active in the labor market), long term unemployment (people unemployed longer than 6 months), the share of people with college degrees taking jobs not requiring those degrees, thus displacing those without, the overall decline in workforce participation for prime working age men and women in the economy since 2000 (as cited among others by this blog and Dean Baker), the recovered hourly wage losses of the bottom half of income distribution, especially men, especially without 4 year college degrees (2/3 of labor force). Good estimates show that with continued robust growth of new jobs (around 180,000) barring any downturns, full employment would not be reached for another 3 years. At that point, wage pressure would be able to begin recovering part of $4 trillion dollars per year share of national income stolen by the top 1% and top 10% of income distributions since 1980 (they each took an additional 10%, to claim 20% and 30% currently, see Saez and Piketty for data).
    2) Only for four years in the past 60 years during a non recession year, has inflation for a year averaged 2% or less while unemployment was 5% or under. Thus historically there is strong contradicting evidence that 2% is obtainable in a well functioning economy, which this current is not (see point 1. for example). Other reasons why 2% is currently a bad target include the overhanging debt of students and many home owners only marginally not underwater, the large Federal debt that could as per WWII debt, could be eroded through higher inflation, the need for tolerating higher inflation to encourage real wage gains and stronger growth because of current under utilization and unused capacity, and give incentive for stronger productivity gains.
    3) The premise that liberals are accepting in the first place, Phillips Curve, NAIRU, Taylor Rule, is all wrong. It ignores reality, and strong evidence that higher prices are caused by of all things higher prices (big surprise). Even correlation, let alone causation, of higher prices from wages, is barely perceptible as this blog has shown in data and graphs. There is also modern monetary theory. But even without accepting MMT, the corporate big business control of prices and the labor market means they dictate prices and squeeze wages nearly at will. Breaking that power to control prices and regain a larger share for labor is a key to restoring a better economy. Using unemployment to control inflation assures this never happens. The 1% rejoices. They laugh all the way to the bank. The liberal economists play their game saying we just need to raise interest rates later rather than sooner. You need to entirely rethink this stupid self defeating system of destroying the economy to save it, instead.
    Nothing happens even because even using U6, 90% of people who want to work have jobs. Although their wages stagnate, they have cell phones and cable TV, fast food, pickup trucks and SUVs.

    The evidence for the three points has been expounded on the pages of this blog. The question then is why does an economist ignore his own data?

    • Smith says:

      Point two typo, should read “for policy makers” not “or policy makers”
      2) The 2% inflation target is a fundamentally wrong and misguided goal for policy makers.
      In evidence section, point 1, it should read
      “unrecovered hourly wage losses” not “recovered hourly wage losses” or “loss”
      The figure 180,000 refers to monthly net new jobs

  3. Blois says:

    The core inflation rate has been below the “target” for eight years and right now it’s 13% below and steady. Raising rates now can mean only one thing: 2% is not a target – it’s not even a cap – it’s a red line.

  4. urban legend says:

    Accelerating? In that graph?