Here’s Why the Fed May Delay Interest Rate Hikes
Policy + Politics

Here’s Why the Fed May Delay Interest Rate Hikes

The fine line that Federal Reserve policymakers have been walking on the question of interest rates seemed to broaden just a bit Monday, suggesting that the expected increase in interest rates above the current near-zero level may not be as imminent as many expected. 

The Federal Open Market Committee, which drove interest rates to historically low levels in reaction to the Great Recession, is now debating when to start raising them again. One of the most important economic indicators the Fed is watching is the inflation rate. The Fed tries to keep the rate somewhere around 2 percent per year, judging that to be a healthy level for the economy. 

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A leading argument against a persistently low interest rate environment is the likelihood that it will spark damaging increases in inflation. Yet there has been no recent evidence of dramatic jumps in the inflation rate. The rate has actually been well under the Fed’s target for more than two years, and on Monday, the Commerce Department reported that rather than rising, the price index measuring personal consumption spending actually dropped from an annualized 1.6 percent in July to 1.5 percent in August. 

Given that at least some in the monetary policy community believe the Fed should actually overshoot its inflation goal for a short time, the news seems likely to push the consensus toward keeping rate lower and for longer. 

In a speech at a conference of the National Association for Business Economics, Federal Reserve Bank of Chicago President Charles Evans said that he remains “very uncomfortable with calls to raise our policy rate sooner than later.” 

Evans, who is not currently a voting member on the FOMC but is influential nonetheless, said that he wants greater assurance the economy has truly entered a growth phase that rising interest rates can’t reverse. 

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“I favor delaying liftoff until I am more certain that we have sufficient momentum in place toward our policy goals. And I think we should plan for our path of policy rate increases to be shallow in order to be sure that the economy’s momentum is sustainable in the presence of less accommodative financial conditions,” he said. “I look forward to the day when we can return to business-as-usual monetary policy, but that time has not yet arrived.” 

Still, interest rates aren’t the only indicator that Fed policymakers are watching. The other is so-called “slack” in the job market. That’s the idea that the current unemployment rate likely understates the problem of joblessness. A certain percentage of the people currently not considered unemployed because they’re not seeking work might be drawn back into the labor market in an improving economy. So there are actually more unemployed – and therefore more reason to continue to stimulate the economy – than we realized. 

Some also argue there’s another source of slack: people currently working part-time only who would prefer to have full time employment. 

There is an active debate over the degree of slack that exists and how to balance the desire to have as many people as possible working and the desire to keep inflation near the Fed’s target level. In a report issued earlier this month, a team of Fed economists found that a significant amount of an observed decline in labor force participation has been attributable to structural changes in the economy – meaning that loose monetary policy will have no impact. But even that paper allowed for the possibility that as much as 1.25 percent of the drop in participation could be attributed to cyclical factors, which are the things monetary policy can help offset. 

Related: Percentage of Jobless Receiving Unemployment Insurance at Record Low 

The view that there is still significant slack appears to be dominant on the FOMC – and it’s the position held by Fed Chair Janet Yellen. 

Given the recent inflation numbers, and key Fed members’ belief that the labor market can still be improved, it seems safe to expect the current “accommodative” stance of the FOMC to remain in place well into 2016. 

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