The Federal Open Markets Committee, the policy-making arm of the Federal Reserve, finishes its September meeting later today. It’s been one of the most anticipated meetings in years as it could mark the first time the committee raises interest rates in more than nine years.
Such a decision would end the Fed’s almost seven-year-old experiment with zero percent interest rates. Many observers have tried to decipher if the committee will push up short-term rates at this meeting—but whether the hiking starts today or later in the year, it’s important to think about what it would signal for both inequality and economic growth.
The monetary policy mandate of the Federal Reserve requires that the central bank promote “maximum employment, stable prices, and moderate long-term interest rates.” Most of the discussion around monetary policy, however, focuses on the Fed’s performance on the first two fronts: employment and inflation.
For many years, the Fed’s goal of stable prices was understood, but no one exactly knew what it considered a stable growth rate of prices. In 2012, however, under former Fed chairman Ben Bernanke, the committee announced that it formally targeted an annual inflation rate of 2 percent over the long run. Many observers had long assumed a 2 percent target, but this made it official. The Fed was now explicitly telling the economy what inflation rate it wants to see.
So how has this target been going? Since the committee announced the target, the inflation rate—measured by the annual percent change in the personal consumption expenditure price index—has been on the decline. In fact, the last time inflation was above 2 percent was April 2012, well over three years ago. This decline might be due to temporary factors that aren’t indicative of the overall health of the U.S. economy. But the core personal consumption expenditure index, which doesn’t include the volatile prices of food and gasoline, has followed almost the exact same path.
With inflation below its target, the Fed doesn’t seem to have a 2 percent inflation target, but rather a 2 percent inflation ceiling. As always, actions speak louder than statements.
When it comes to employment, there has been quite a bit of progress in putting the labor market back on the right track. The official unemployment rate has dropped significantly from its peak of 10 percent in October 2009, sitting at 5.1 percent as of this August.
Of course, as is well known, the decline in the unemployment rate isn’t a perfectly sunny story. The decline in the labor force participation rate, some of which is due to the aging of the Baby Boom generation and discouraged workers leaving the labor force, has led to a drop in the unemployment rate that isn’t solely from more workers getting jobs. Looking at the employment-to-population ratio for prime-age workers (those ages 25 to 54) shows a recovering labor market, but one that is far from full employment. An economy even approaching full employment would show signs of accelerating wage growth, but there is no sign of that—annual nominal wage growth is still plugging away at 2 percent. Acceleration and the approach of maximum employment doesn’t seem to be around the corner.
Hiking short-term interest rates by 0.25 percentage points won’t derail the current recovery. But a hike now would send a powerful signal from the Federal Reserve—and the data on inflation and the signs from the labor market give no indication that a hike is required this month. Employment is not at its maximum level, and inflation is far from the Fed’s stated target. An unnecessary tilt against growth would not only slow down the pace of the overall economic recovery but also potentially exclude millions of workers from reaping the benefits of further growth. Either wage gains would continue to be subpar or employment growth would slow down. Or likely both.
Central bankers are seemingly obsessed with their perceived credibility, especially when it comes to protecting against accelerating inflation. But in light of the current data, perhaps members of the FOMC should consider the effect of hiking too early on their credibility.
