Must-Read: Narayana Kocherlakota: The Fed Is About to Make a Mistake

Must-Read: Narayana Kocherlakota: The Fed Is About to Make a Mistake:

More than seven years after the recovery began in mid-2009, inflation remains below the central bank’s 2-percent target…

…indicating that the economy is still operating below potential. As of July, consumer prices… excluding volatile food and energy goods and services… were up 1.6 percent. Worse, markets appear to be losing confidence that the Fed will ever reach its target: Yields on Treasury bonds suggest that traders expect inflation to average less than 2 percent five to 10 years from now. As the experience of the Bank of Japan indicates, restoring such confidence is not easy…. Although the unemployment rate has returned to its 2007 level of 5 percent, the fraction of Americans in their prime working years who have a job remains well below its pre-recession level.  All this argues for the Federal Open Market Committee, the central bank’s policy-making arm, to provide added stimulus by cutting interest rates….

Unfortunately, I’m confident that the Fed won’t cut rates. Doing so now might require officials to raise rates more rapidly in the future–an outcome that they are, for reasons that are unclear to me, determined to avoid. So the central bank will either raise rates by a quarter percentage point or do nothing. The latter appears more likely, given that two Fed governors have spoken out in favor of caution. The last time the Fed took an action from which two governors dissented was in 1993. In either case, it will be the wrong move.