What’s the Fed’s Next Move?
At least for the short run, the Federal Reserve’s interest
rate increase has created one clear winner: the banks. When the Fed announced
on Wednesday that it would raise its benchmark rate to a range of 0.25 to 0.5
percent, banks raised the rates they charge on many loans but not the rates
they pay to depositors. That widening spread means higher bank profits.
But it is hard to see how the increase will benefit the
economy as a whole. The unemployment rate has held steady recently, at 5
percent, but the underemployment rate which includes the unemployed,
part-timers who need full-time work and jobless workers who have apparently
given up looking is still at nearly 10 percent.
One result of those slack conditions is that pay raises for
most workers are still few and far between. With no evidence of inflation in
wages or in consumer prices, there was simply no need at this time for the Fed
to risk slowing the economy by raising rates.
Banks tend to favor higher rates out of fear that an
outbreak of inflation will erode the value of loans. For most of the past
several decades, Fed policy makers tended to indulge these fears by giving
priority to fighting inflation, even when doing so stifled jobs and wages.
But from the end of 2008 until this week, the Fed kept
interest rates near zero, even though its low rate policy and other stimulus
measures did not benefit the banks directly. This week’s interest rate
increase, though small, is significant, because it is a sign that the Fed has again
let fighting inflation take precedence over pursuing full employment.
There is reason to hope, however, that the Fed will be
cautious about future increases. Recent comments by Janet Yellen, the
chairwoman of the Fed, indicate that the increase is more to appease inflation
hawks than to definitively change course. And in its statement, the Fed said it
wanted to see actual evidence of rising inflation before it raised rates again.
It should not just stick to that pledge; it should also explain in greater
detail what it would consider to be a troubling level of inflation.
For example, the Fed’s inflation target of 2 percent is not
a ceiling that inflation cannot surpass. The Fed should be clear that the
target is a desired average inflation rate over time. Specifically, wages can
rise faster than the inflation target without pulling up prices as long as
labor productivity keeps growing apace.
In fact, the risk that wages will continue to stagnate as
they have for decades for most people should be a far more worrisome issue for
policy makers than a distant and theoretical risk of inflation.