Tag: Monetary Policy

The FOMC Minutes Show Officials Divided on Need for More Rate Hikes

Posted on by slightbourne@noblecapitalmarkets.com

The Federal Reserve released the full minutes from its pivotal September policy meeting on Wednesday, providing critical behind-the-scenes insight into how officials view the path ahead for monetary policy.

The minutes highlighted a growing divergence of opinions within the Fed over whether additional large interest rate hikes are advisable or if it’s time to ease off the brakes. This debate reflects the balancing act the central bank faces between taming still-high inflation and avoiding tipping the economy into recession.

No Agreement on Further Tightening

The September gathering concluded with the Fed voting to lift rates by 0.75 percentage point for the third straight meeting, taking the federal funds target range to 3-3.25%. This brought total rate increases to 300 basis points since March as the Fed plays catch up to curb demand and cool price pressures.

However, the minutes revealed central bankers were split regarding what comes next. They noted “many participants” judged another similar-sized hike would likely be appropriate at upcoming meetings. But “some participants” expressed reservations about further rate increases, instead preferring to monitor incoming data and exercise optionality.

Markets are currently pricing in an additional 75 basis point hike at the Fed’s December meeting, which would fulfill the desires of the hawkish camp. But nothing is guaranteed, with Fed Chair Jerome Powell emphasizing policy will be determined meeting-by-meeting based on the dataflow.

Concerns Over Slowing Growth, Jobs

According to the minutes, officials in favor of maintaining an aggressive policy stance cited inflation remaining well above the Fed’s 2% goal. The labor market also remains extremely tight, with 1.7 job openings for every unemployed person in August.

On the flip side, officials hesitant about more hikes mentioned that monetary policy already appears restrictive thanks to higher borrowing costs and diminished liquidity in markets. Some also voiced concerns over economic growth slowing more abruptly than anticipated along with rising joblessness.

The consumer price index rose 8.3% in August compared to a year ago, only slightly lower than July’s 40-year peak of 8.5%. However, the Fed pays close attention to the services and wage growth components which indicate whether inflation will be persistent.

Data Dependency is the Mantra

The minutes emphasized Fed officials have coalesced around being nimble and reacting to the data rather than sticking to a predefined rate hike plan. Members concurred they can “proceed carefully” and adjust policy moves depending on how inflation metrics evolve.

Markets and economists will closely monitor upcoming October and November inflation reports, including wage growth and inflation expectations, to determine if Fed policy is gaining traction. Moderating housing costs will be a key tell.

Officials also agreed rates should remain restrictive “for some time” until clear evidence emerges that inflation is on a sustainable path back to the 2% target. Markets are pricing in rate cuts in late 2023, but the Fed wants to avoid a premature policy reversal.

While Americans continue opening their wallets, officials observed many households now show signs of financial strain. Further Fed tightening could jeopardize growth and jobs, arguments made by dovish members.

All About Inflation

At the end of the day, the Fed’s policy decisions will come down to the inflation data. If price pressures continue slowly cooling, the case for further large hikes diminishes given the policy lags.

But if inflation remains sticky and elevated, particularly in the services sector or wage growth, hawks will maintain the pressure to keep raising rates aggressively. This uncertainty means volatility is likely in store for investors.

For now, the Fed is split between officials who want to maintain an aggressive tightening pace and those worried about going too far. With risks rising on both sides, Chairman Powell has his work cut out for him in charting the appropriate policy course.

Why the Fed Adjusts to Steer Inflation to 2%

Posted on by phoffman@channelchek.com
Image Credit: Shvets Production (Pexels)

Fed Wants Inflation to Get Down to 2% – But Why Not Target 3%? Or 0%?

What’s so special about the number 2? Quite a lot, if you’re a central banker – and that number is followed by a percent sign.

That’s been the de facto or official target inflation rate for the Federal Reserve, the European Central Bank and many other similar institutions since at least the 1990s.

But in recent months, inflation in the U.S. and elsewhere has soared, forcing the Fed and its counterparts to jack up interest rates to bring it down to near their target level.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Veronika Dolar, Assistant Professor of Economics, SUNY Old Westbury.

As an economist who has studied the movements of key economic indicators like inflation, I know that low and stable inflation is essential for a well-functioning economy. But why does the target have to be 2%? Why not 3%? Or even zero?

Soaring Inflation

The U.S. inflation rate hit its 2022 peak in July at an annual rate of 9.1%. The last time consumer prices were rising this fast was back in 1981 – over 40 years ago.

Since March 2022, the Fed has been actively trying to decrease inflation. In order to do this, the Fed has been hiking its benchmark borrowing rate – from effectively 0% back in March 2022 to the current range of 3.75% to 4%. And it’s expected to lift interest rates another 0.5 percentage point on Dec. 14 and even more in 2023.

Most economists agree that an inflation rate approaching 8% is too high, but what should it be? If rising prices are so terrible, why not shoot for zero inflation?

Maintaining Stable Prices

One of the Fed’s core mandates, alongside low unemployment, is maintaining stable prices.

Since 1996, Fed policymakers have generally adopted the stance that their target for doing so was an inflation rate of around 2%. In January 2012, then-Chairman Ben Bernanke made this target official, and both of his successors, including current Chair Jerome Powell, have made clear that the Fed sees 2% as the appropriate desired rate of inflation.

Until very recently, though, the problem wasn’t that inflation was too high – it was that it was too low. That prompted Powell in 2020, when inflation was barely more than 1%, to call this a cause for concern and say the Fed would let it rise above 2%.

Many of you may find it counterintuitive that the Fed would want to push up inflation. But inflation that is persistently too low can pose serious risks to the economy.

These risks – namely sparking a deflationary spiral – are why central banks like the Fed would never want to adopt a 0% inflation target.

Perils of Deflation

When the economy shrinks during a recession with a fall in gross domestic product, aggregate demand for all the things it produces falls as well. As a result, prices no longer rise and may even start to fall – a condition called deflation.

Deflation is the exact opposite of inflation – instead of prices rising over time, they are falling. At first, it would seem that falling and lower prices are a good thing – who wouldn’t want to buy the same thing at a lower price and see their purchasing power go up?

But deflation can actually be pretty devastating for the economy. When people feel prices are headed down – not just temporarily, like big sales over the holidays, but for weeks, months or even years – they actually delay purchases in the hopes that they can buy things for less at a later date.

For example, if you are thinking of buying a new car that currently costs US$60,000, during periods of deflation you realize that if you wait another month, you can buy this car for $55,000. As a result, you don’t buy the car today. But after a month, when the car is now for sale for $55,000, the same logic applies. Why buy a car today, when you can wait another month and buy a car for $50,000 next month.

This lower spending leads to less income for producers, which can lead to unemployment. In addition, businesses, too, delay spending since they expect prices to fall further. This negative feedback loop – the deflationary spiral – generates higher unemployment, even lower prices and even less spending.

In short, deflation leads to more deflation. Throughout most of U.S. history, periods of deflation usually go hand in hand with economic downturns.

Everything in Moderation

So it’s pretty clear some inflation is probably necessary to avoid a deflation trap, but how much? Could it be 1%, 3% or even 4%?

Maybe. There isn’t any strong theoretical or empirical evidence for an inflation target of exactly 2%. The figure’s origin is a bit murky, but some reports suggest it simply came from a casual remark made by the New Zealand finance minister back in the late 1980s during a TV interview.

Moreover, there’s concern that creating economic targets for economic indicators like inflation corrupts the usefulness of the metric. Charles Goodhart, an economist who worked for the Bank of England, created an eponymous law that states: “When a measure becomes a target, it ceases to be a good measure.”

Since a core mission of the Fed is price stability, the target is beside the point. The main thing is that the Fed guide the economy toward an inflation rate high enough to allow it room to lower interest rates if it needs to stimulate the economy but low enough that it doesn’t seriously erode consumer purchasing power.

Like with so many things, moderation is key.