Focus On The Fed

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Fed Officials Say Economy Is Ready for Higher Rates
By BINYAMIN APPELBAUMFEB. 21, 2018

WASHINGTON — Robust economic growth has increased the confidence of Federal Reserve officials that the economy is ready for higher interest rates, according to an official account of the central bank’s most recent policymaking meeting in late January.

The Fed did not raise its benchmark interest rate at the meeting on Jan. 30 and 31, but the account reinforced investor expectations the Fed would raise rates at its next meeting in March.

The account said Fed officials have upgraded their economic outlooks since the beginning of the year and listed three main reasons: The strength of recent economic data, accommodative financial conditions and the expected impact of the $1.5 trillion tax cut that took effect in January.

“The effects of recently enacted tax changes — while still uncertain — might be somewhat larger in the near term than previously thought,” said the meeting account, which the Fed published Wednesday after a standard three-week delay.

The Fed is seeking to raise rates gradually to maintain control of inflation without impeding an economic expansion that is nearing the end of its ninth year, one of the longest stretches of continuous economic growth in American history.

A wave of turbulence passed through global equity markets in the days after the Fed’s January meeting. The government reported an unexpected increase in wages, and investors worried the Fed would respond by raising rates a little more quickly. Then Congress passed a plan increasing government spending, tossing more logs onto the fire.

So far, however, Fed officials have treated the stronger economic news as a reason to carry out their plans for gradual rate hikes, rather than as a reason to start raising rates more quickly. Most Fed officials predicted in December the Fed would raise rates three times in 2018, as it did last year.

“If the economy evolves as I anticipate, I believe further increases in interest rates will be appropriate this year and next year, at a pace similar to last year’s,” Loretta Mester, president of the Federal Reserve Bank of Cleveland, said this month.

In the policy statement the Fed issued after the January meeting, the central bank outlined its approach to raising rates, saying it “expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate.”

The meeting account said the addition of the word “further” in that statement reflected the increased confidence among officials that the Fed would continue raising rates.

Jesse Edgerton, an economist at JPMorgan Chase, said the Fed’s increased confidence was likely to translate eventually into more interest rate increases than the three Fed officials predicted.

“We think increased confidence in the need for further hikes will accompany a perceived need for more than three hikes among a growing portion of the committee,” he wrote Wednesday.

And the minutes did suggest the Fed might eventually raise rates to a level higher than financial markets presently anticipate. Fed officials predicted in December that the Fed’s benchmark rate would come to rest around 2.8 percent, well below its precrisis level. The rate is currently in a range between 1.25 percent and 1.5 percent.

At the January meeting, some Fed officials raised the possibility that the strength of economic growth might raise that ceiling. The Fed would welcome such a development, because it would preserve more room to reduce rates in future downturns.

The persistent question mark is inflation. The Fed aims to keep prices rising at an annual rate of 2 percent, but it has consistently fallen short of that goal since the end of the last recession in 2009.

The minutes said the Fed has gained some confidence in its prediction that inflation will rise toward 2 percent. The economy continues to gain strength, and the minutes said a decline in the foreign exchange value of the dollar was also likely to put upward pressure on inflation. Lower exchange rates translate into higher prices for imported goods.

But the Fed has made the same predictions repeatedly, without success, and the minutes said the Fed intends to raise rates slowly as it continues to watch inflation closely. Some officials argue that the Fed should stop raising rates until inflation shows clear signs of revival.

The Fed has good reason for its uncertainty about inflation: It lacks a convincing explanation of what causes inflation, or a model that accurately predicts future inflation.

In a presentation at the January meeting, economists on the Fed’s staff told policymakers that the most popular explanations had significant flaws. One class of theories says inflation is produced by excess demand for available resources. This suggests inflation should rise as growth approaches its natural speed limit, a pattern that can be seen in some historical data but is difficult to find in recent decades. Another class of theories argues, with some circularity, that inflation is determined by expectations about inflation. It is not clear, however, how those expectations are formed.

The account said that “almost all” Fed officials responded by expressing a continued commitment to both theories. They said they intended to raise interest rates as the economy gains strength, and to seek to maintain public confidence in the 2 percent inflation target.

The January meeting was the final meeting for Janet L. Yellen, who concluded her four-year term as the Fed’s chairwoman in early February. Her successor, Jerome H. Powell, is scheduled to make his public debut when he testifies before House and Senate committees next week.

https://www.nytimes.com/2018/02/21/business/economy/fed-economy.html?