The Federal Reserve voted last week to keep interest rates unchanged at 0%. There are some dissenting opinions on the policy setting committee, with Richmond Fed officer Jeffrey Lacker voting for increased rates. Furthermore, St. Louis Fed President James Bullard – sadly, not a voting member of the policy committee – went on CNBC on September 21st to advocate for increasing rates.
The Federal Reserve’s decisions to leave rates unchanged are not made lightly, and I don’t want to imply that they haven’t been appreciating the economic data. Recall that the Federal Reserve’s primary goal is price stability. The Federal Reserve’s secondary goal within its dual mandate is full employment. If you combine both elements of the dual mandate, you could fairly interpret the Fed’s goal is to keep monetary policy as accommodative as possible without getting inflation over 3%.
Given that interpretation, how are they doing? I’d argue, they are succeeding with honors. Are prices stable? Yes. Is inflation out of control? No. If anything, inflation is a little below their unofficial 2%-3% target range. So, depending on the data you’re looking at, there is a perfectly valid case to make for keeping rates indefinitely low.
So why do some economists and market commentators want to increase rates? The answer: psychology. The current Federal Reserve policy is a vestige of the historical actions made during a period of extreme crisis. No, the economy isn’t perfect right now, but it is certainly not in a period of overwhelming crisis any longer. If anything, the United States is currently the resilient leader of world economies – emerging and developed. A marginal increase in rates – a mere 25 basis points – could affect the psychology of the market in a positive way, spurring investment as borrowers hurry to capture low rates. Also, the Fed will finally have a credible action to respond to inevitable slowdowns in the economy without resorting to asset purchasing programs like QE4.