The case against the Fed raising interest rates

No love for doves.
No love for doves.
Image: Reuters/Thomas Peter
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The Federal Reserve is going to raise interest rates. The market thinks so. Economists think so (paywall). Based on all the talking she’s done, Fed chair Janet Yellen wants you to think so, too.

But that’s not to say it’d be right for the Fed to do so. While 25 basis points in the fed funds rate will probably not send the economy careening into a ditch, there’s still plenty of people suggesting Yellen & Co. hold their fire, and at least one Fed governor thinks they should cross the zero lower bound:

Even the Financial Times wants the Fed to chill for a bit (paywall) and thinks that the only reason it can’t is of its own making:

Having come this far in signalling that interest rates are about to rise, it would probably be more disruptive if the Fed sat on its hands on Wednesday than if it moved. Financial markets — and, most likely, policymakers in the rest of the world — have priced in an increase with near-certainty.

While the US economy has largely recovered financially—and the Fed itself held off from raising rates back in September in large part for financial reasons—not everything is quite peachy keen. For one, unemployment is only just now hitting its so-called “natural rate,” or the lowest level that it can sustain without inviting more inflation:

But things look like they have room to improve further still if you’re looking at the broadest possible measure of joblessness, which includes people marginally attached to the labor force or people working part-time for economic reasons:

And though consumer price index inflation (at least the core measure) appears to be getting back to normal, the Fed’s preferred gauge, personal consumption expenditure price index inflation, is still a ways from being where the Fed wants it to be.

Economist Josh Bivens, research and policy director for the left-leaning Economic Policy Institute, suggested in a blog post that a big reason behind weak inflation has been that workers have lost leverage and can’t demand higher wages like they used to, and that raising rates now might sap what little strength they’re gaining:

The pressure to raise rates now, even in the face of a complete absence of inflationary pressures in the data, reflects a couple of strands of conventional thinking that are deeply damaging to prospect of workers’ wages rising anytime in the near future.

If that’s the case, why hike? Even if one argues that Fed’s main job at this point is setting expectations for economic and monetary activity, it’s not clear the market expects inflation to suddenly skyrocket. The five-year-five-year expectation of inflation, a convoluted measure of market expectations that asks respondents to imagine themselves five years in the future and then forecast inflation in an additional five years, has been pretty low for some time as uncertainty in oil markets leaves a dark cloud over the global economy.

If the employment picture is still murky, and inflation is nowhere to be seen, then the Fed doesn’t really have much of a reason to increase rates. Face it: the Fed is trapped in a glass case of market expectations.