December 16, 2014
There is growing pressure on the Fed to abandon its zero interest rate policy. The big question is why?
Just to remind people, the reason the Fed typically raises interest rates is to slow the economy to prevent problems with inflation. Higher interest rates will discourage people from buying cars and houses. Higher interest rates will discourage businesses from investing and state and local governments from borrowing for infrastructure and other needs. Through these and other channels, higher interest rates will reduce demand and slow growth. This will mean fewer jobs. That is turn means less upward pressure on wages, which will reduce inflationary pressures in the economy.
Given where the economy is today, and where we are likely to be in the near-term future, does anyone seriously believe that we have to worry about inflation rising too rapidly, too many people having jobs, and too much wage growth? It’s hard to construct this story from the data.
Over the last year, the core personal consumption expenditure deflator (which excludes volatile food and energy prices) has risen at just a 1.5 percent annual rate, well below the Fed’s 2.0 percent target. If we just look at the annual rate over the last quarter compared with the prior quarter, the rate of increase is just 1.4 percent. And, if people are troubled by pulling out food and energy prices, the overall deflator was also 1.5 percent over the last year and just 1.3 percent over the last quarter.With oil prices having fallen sharply in recent weeks, the direction for the inflation rate going forward is almost certainly likely to be lower rather than higher.
And, it is important to remember that the 2.0 percent target was supposed to be an average, not a ceiling. With several years of sub-2.0 percent inflation under our belts, the Fed can allow the inflation rate to rise to 2.5 percent or even 3.0 percent and still be in line with its target. So why exactly would the Fed be trying to avoid higher inflation right now or in the near-term future?
Given the lack of evidence of any problem with inflation, it is hard not to see the rest of story as rather pernicious. After all, if the Fed raises rates it is keeping people from getting jobs and preventing tens of millions of workers who do have jobs from getting wage increases. It is understandable that people would be a bit upset over this. Imagine the Fed was preventing your father, mother, brother, or sister from getting a job they needed to pay the rent or mortgage.
We see politicians getting hysterical over the prospect that President Obama may delay or stop the Keystone Pipeline, costing 10,000 or so temporary jobs. Imagine the Fed costing 200-300 times as many jobs by slowing the recovery. Shouldn’t this warrant some pretty serious anger? Job loss is always bad, but in the case of the pipeline the purpose is to protect the environment. There is no obvious purpose to a Fed interest rate hike in the near future.
This raises the question of whether the need to raise interest rates should be seen as some sort of fashion statement; it’s the sort of thing that central banks are supposed to do. If that sounds silly, back in 2010 the OECD made an argument for the “normalisation” of interest rates that was pretty much along these lines. After all, there was even less threat of inflation back in 2010 than there is today.
Janet Yellen is an outstanding economist and undoubtedly the clearest thinker we have had as Fed chair for many decades. But she does not unilaterally decide policy and pressure is clearly building on her to raise rates. It is important that Fed see pressure in the opposite direction from people who care more about jobs and wages than central bank fashions.
