Why Is The Fed Raising Interest Rates As Fast As It Is?

Why Is The Fed Raising Interest Rates As Fast As It Is?

I have a theory that at least some people at the Fed are supporting interest rate increases not because they are worried about incipient inflation that must be nipped in the bud in advance under a regime of inflation targeting, but because they are looking over the horizon and worrying about a possible recession in the not-too-distant future, and they want to be able to have interest rates high enough that they can then engage in lowering them as a stimulative policy tool under the circumstances.  If they are too low, then extraordinary measures will need to be used, and some of those measures may not be available in the future.

This theory is based on nothing solid at all, nothing.  I think that those who may be thinking this (and my likely candidate(s) would be people at the very top) are constrained in speaking openly due both to the current institutional arrangement of consensus decisionmaking within an established inflation targeting system with a 2% inflation target, not to mention pressure not to talk about possible future dangers.  The current line is that the economy is doing well, and certainly it is on the standard measures of unemployment and inflation, even if the former could be better and wages could be rising more rapidly.  Indeed, it is this good performance that is supposedly underlying the moves to raise interest rates and possibly “normalize” the balance sheet (which I doubt there will be too much action on).  But my theory is that for some of them it is a matter of trying to “normalize” on interest rates as well while the possibility of normalizing is possible, while the economy is doing fairly well and one can raise them without obviously slowing things down noticeably, so that indeed there will be the ability to lower them again in the future when necessary.

He did not put this theory forward, but it was reading the recent column by Larry Summers that appeared in the Washington Post on Monday was been linked to by Mark Thoma today (unable to make that link, sorry) and also can be gotten to at larrysummers.com/2017/08/14/why-the-federal-reserves-job-will-get-harder.  He is focused on the upcoming ending of the term of his rival as Chair of the Fed, Janet Yellen, and is worried about who Trump will pick and what will happen.  While stating that he would have “preferred a slower pace of interest rate adjustment,” he bottom lines that “Overall it has done well in recent years” (even though he did not get picked to be Chair).

While he thinks the economy is currently doing pretty well, looking forward he worries tha it is “brittle” with numerous dangers, and opines that there is a two thirds chance of a recession during the next Fed Chair’s term.  He then notes how the still low interest rates will make it hard to use the interest rate tool to stimulate the economy, making it difficult for the Fed to do much.  He does not make the leap I did to the possibility that this fact may be on the minds of at least some people at the Fed, although they really cannot openly say it.

I agree with his concerns about what is coming due to the political situation, with “major risk now of presidential interference” in the Fed, and he makes disparaging remarks about the president quite reasonably so.  He also notes that the “temper of the times has turned against technical expertise in favor of populist passion.” There is reason to be concerned about what he will do.

But in the meantime some people at the Fed may be doing their best to make it possible for the Fed to do something in the future when the need will surely arise.

Barkley Rosser

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