Why no rate rise in September? Because there is a US Election in November. An unwritten Fed commandment is “Thou shalt not appear to overtly meddle in politics.“** Without a gun-to-the-head turn of events, they will put it off until December.
What I am still trying to figure out why we keep getting these saber-rattling hints from various Fed governors trying to keep the idea of a September rate rise in play? They mostly serve to diminish the Fed’s already-battered credibility. So what is driving them?
- The internal debate played out on a public stage?
- An effort to keep the markets on edge? To what end?
- Some sort of “talk-tough before we raise the inflation target to 3% whilst raising rates” strategy?
My hope is that the more consequential Fed news was the SF Fed governor’s recent piece questioning today’s (totally arbitrary) 2% inflation “target. 2% has become a de facto ceiling – as “targets” are wont to become. Which has condemned us to 1%-2% inflation. Which is pretty obviously too low. Why? See “negative interest rates, general malaise, and Donald Trump…” I’d have though that was all obvious enough, although clearly a lot of people haven’t grokked it yet.
The SF Fed’s paper is short and worth a read. Excerpts and a link below. My takes are…
- It is hopefully a sign of a shift as much as a plea for it. Does the Fed shift to a 3% inflation target post election? He certainly suggests they should. Because the target has become a ceiling (as predicted by many), 3% really means about 2%-3% inflation vs todays 1%-2%. 2%-3% would be in line with the original idea of 2% as the mid-point target of the inflation range, not the cap.
- This is about as close to a Fed Governor begging for fiscal stimulus. Message to Congress etc… “stop diddling around with the politics already!. We’re out of bullets and this is deadly serious!“
- The other sub-text is “We all know nothing will happen until after the election but we need to get teed up on this messaging shift now!“
- He is right IMHO. Especially about fiscal policy and the Fed being out of bullets.
- The market’s recent pep might be a sign we resolve this intelligently and positively. Which would be a pleasant change…
** Note that its OK for the Fed to meddle in politics by NOT doing anything. See Greenspan’s quiet contribution to Bush II’s re-election by leaving rates too low for too long. Remember that the Fed leans Republican (see “regulatory capture“). That was pretty obvious “action,” but in a passive aggressive way that didn’t risk blame. Just a subsequent housing bubble and financial crisis…
Monetary Policy in a Low R-star World Excerpts Below
“The critical implication of a lower natural rate of interest is that conventional monetary policy has less room to stimulate the economy during an economic downturn, owing to a lower bound on how low interest rates can go. This will necessitate a greater reliance on unconventional tools like central bank balance sheets, forward guidance, and potentially even negative policy rates.
In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher (Reifschneider and Williams 2000). We have already gotten a first taste of the effects of a low r-star, with uncomfortably low inflation and growth despite very low interest rates.
Unfortunately, if the status quo endures, the future is likely to hold more of the same—with the possibility of even more severe challenges to maintaining price and economic stability.
To avoid this fate, central banks and governments should critically reassess the efficacy of their current approaches and carefully consider redesigning economic policy strategies to better cope with a low r-star environment. This includes considering fiscal and other policies aimed at raising the natural interest rate, as well as alternative monetary and fiscal policies that are more likely to succeed in the face of a low natural rate.
Taking each of those in turn, I’ll start with policies aimed at raising r-star by affecting its underlying determinants.
- One potential avenue is to increase longer-run growth an d prosperity through greater longterm investments in education, public and private capital, and research and development. Despite growing skepticism and endless column inches questioning whether college is worth the cost, the return on investment in post-secondary education is as high as ever (Autor 2014, Daly and Cao 2015). Likewise, returns on infrastructure and research and development investment are very high on average (Jones and Williams 1998, 2000, Fernald 1999).
- Turning to policies that can help stabilize the economy during a downturn, countercyclical fiscal policy should be our equivalent of a first responder to re cessions, working hand-in-hand with monetary policy. Instead, it has too often been stuck in a stop-and-go cycle, at times complementing monetary policy, at times working against it. This is not unique to the United States; Japan, and Europe have also fallen victim to fiscal consolidation in the midst of an economic downturn or incomplete recovery.
One solution to this problem is to design stronger, more predictable, systematic adjustments of fiscal policy that support the economy during recessions and recoveries (Williams 2009, Elmendorf 2011, 2016). These already exist in the form of programs such as unemployment insurance but are limited in size and scope. Some possible ideas for the United States include Social Security and income tax rates that move up or down in relation to the national unemployment rate, or federal grants to states that operate in the same way. Such approaches could be designed to be revenue-neutral over the business cycle; they also could avoid past debates over fiscal stimulus by separating decisions on countercyclical policy from longer-run decisions about the appropriate role of the government and tax system. Indeed, economists across the political spectrum have championed these ideas (Elmendorf and Furman 2008, Taylor 2000, 2009).
