Inflation Almost There, But Interest Rates Are Not

Inflation Almost There, But Interest Rates Are Not

The Federal Reserve Board acknowledged at its meeting last week that the rate of inflation is “almost” at its 2% target level.

The last impediment to raising interest rates to their historically normal level has been eliminated. The Fed can declare “mission accomplished,” as Michael Feroli, chief U.S. economist at JPMorgan Chase, said last week.

The Federal funds interest rate since 1954.

So why is the Fed funds rate still just 1.5% to 1.75%?

The Fed historically has sought to keep the rate between 2% and 5%, but in 1979 and 1980 it reached – and even exceeded – 20%, as the chart shows. The Fed funds rate is the rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis.

The Fed is expected to increase rates another 0.25% in June, which will mark its seventh rate increase since December 2015, but that just brings the rate up to the low end of where it’s typically been historically.

The 2% Obsession

The Fed’s obsession with a 2% rate of inflation, which we’ve criticized in the past, remains a mystery.

“Raising rates too slowly would make it necessary for monetary policy to tighten abruptly down the road, which could jeopardize the economic expansion,” Fed Chairman Jerome Powell said in a recent speech. “But raising rates too quickly would increase the risk that inflation would remain persistently below our 2% objective.”

But so what? The rate of inflation has consistently been close to 2% over the past year or so, but it declined in March 2017 because of a price war between wireless phone carriers. Now that year-long stats don’t include that decline, the inflation rate has essentially reached its target.

According to The Wall Street Journal, “Fed officials see 2% inflation as consistent with an economy with healthy demand for goods and services.”

The Fed wants to avoid deflation, but a price war between wireless carriers, which benefits consumers, is not inconsistent with a “healthy demand for goods and services.”

In its policy statement, the Fed used its oft-repeated statement, “Consistent with its statutory mandate, the (Federal Open Market) Committee seeks to foster maximum employment and price stability.”

Wouldn’t “price stability” mean an inflation rate of 0%?

In its years-long effort to boost inflation, the Fed is likely to overshoot its goal and produce higher inflation, which would potentially have a bigger negative impact on the economy than an inflation rate of less than 2%.

When Feroli said “mission accomplished,” he added a caveat: “for now.”

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