Fed Hikes Rates While Inflation Stays Below Target
This week the Federal Reserve once again raised interest rates, bringing them from 1% to 1.25%. While this move was completely expected — a CNBC poll found 100% of respondents predicting it — some wondered why the Fed is still raising rates when inflation has been weak. Despite unemployment shrinking to just 4.3%, getting inflation above the Fed’s target goal of 2% has proven difficult.
So why is inflation being so stubborn? That’s what Fed chair Janet Yellen must be wondering. After all, the theory goes that, when employment rates climb above a certain level, inflation increases as workers are able to negotiate higher salaries. Economists refer to this concept as NAIRU — Non-Accelerating Inflation Rate of Unemployment. Speaking to reporters, Yellen said she believes this principle will kick in over the next few months, raising inflation and justifying the decision to raise rates. As the New York Times reports, Yellen added that, when it came to inflation, she and the Fed had “taken note of the fact that there have been several weak readings,” but that, “it’s important not to overreact to a few readings and data on inflation can be noisy.”
Adding to the confusion, although this rate hike was seemingly a sure thing, it’s unclear to many when the next hike will be. According to the same CNBC poll of money managers and economists, 54% foresee the next rate change happening in September, which is far from a consensus. However, with 21% expecting a hike in December, it does seem likely there will be at least one more round of hikes before the year’s end. This would mark the third hike in calendar 2017 with the first happening back in March.
The problem with predicting the economic outlook from here is that we’re still waiting on many policy changes like tax reform that seemed inevitabilities with the election of President Donald Trump. Instead the administration has been embroiled in scandal after scandal with hardly a mention of much else. As Neil Dutta of Renaissance Macro put it, “2017 is shaping up to be a year of investigations, not legislation.”
Still, Yellen seems optimistic about the U.S. economy’s course even if critics are a bit puzzled by that position. That said, some analysts are on the page as the Fed chair. Take for example JPMorgan strategist Gabriela Santos who said of the Fed’s faith, “I do think it is justified. They’re now maybe feeling a little bit more comfortable that the economy’s actually much more resilient than they even realized over the past few years.” For the record, Santos is on Team September in terms of when the next hike will be.
Just as our political times are proving to be quite interesting, our economic times are following suit with their unpredictability. While the Fed is clearly ready to declare the Great Recession dead and buried, the past still seems to be haunting them and playing a few tricks on their inflation goals. But until fortunes change in the Executive Branch and beget legislative developments, it seems likely that the Fed will have to continue navigating through uncertain waters on what was supposed to be a straight course.