Ever since Fed officials started talking about raising rates, I and others have raised the spectre of asymmetric risk: the risk that a forthcoming rate hike will lead to slower growth is greater than the risk of faster inflation, and the former would be much more damaging to American households than the latter.
Paul K put this all very well in an interview the other day:
If the Fed raises rates too soon, we risk getting caught in another lost decade. So the risks are hugely asymmetric. I really find it quite mysterious that the Fed is eager to raise rates given that, they’re going to be wrong one way or the other, we just don’t know which way. But the costs of being wrong in one direction are so much higher than the costs of being the other.
[See my recent piece on the racial implications of these risks.]
It’s not obvious that the FOMC (the committee that sets rates) is necessarily going to be wrong, though I suspect Paul’s right, in that I don’t see pressures from nascent wage or price growth waiting pounce around the next corner…I still see considerable slack, especially in paychecks.
Those who want to argue that the Fed may actually be timing this right are making a preemptive case, but given the asymmetries, they need MUCH more in the way of data to make a persuasive case.
If it were me, I wouldn’t be talking about raising yet, but I do think there’s one reason for doing so: there’s another recession out there somewhere and the Fed, worried about hitting the zero lower bound again, wants the fed funds rate to be on a perch high enough such that they have room to come down without hitting zero.
This is especially important if you believe, as I do, that an austerity-smitten Congress will not move fast enough with counter-cyclical fiscal policy.
If that’s truly their motivation–and again, I wouldn’t go there but I don’t think it’s crazy to do so–then the thing to do is to keep the rate path very shallow at first. The expectation is for the first rate hike to be 25 basis points (0.25%), which meets this criterion.