Outside the Beltway

Federal Reserve Not Worried About Economy Overheating

The Federal Reserve sees the economy staying relatively the same for the foreseeable future, which is both a good and bad thing.

Doug Mataconis · Thursday, May 24, 2018 · 6 comments

Based on its most recently released minutes, the Federal Reserve Board doesn’t seem to be too worried about the economy overheating:

WASHINGTON — Federal Reserve officials gave no indication that they are likely to speed up their pace of interest rate increases during their most recent two-day meeting, suggesting instead that they would be willing to allow the inflation rate to rise slightly above 2 percent for a “temporary period,” while the economy continues to expand.

Minutes from the meeting, which ended May 2 and are released after a typical three-week delay, reveal Fed officials are on track to raise rates again in June. The minutes also indicate officials are less worried about inflation rising above 2 percent, its current level and the Fed’s target rate, than they are about the rate of inflation dipping again.

Officials continue to see the economy as strong, but they remain worried about global trade tensions, including potential damage from American and Chinese tariffs and the possibility that uncertainty over trade policy could already be crimping business investment in the United States.

Officials at the Federal Open Market Committee concluded the May 2 meeting with a unanimous decision to leave the Fed’s benchmark interest rate unchanged, at a range from 1.5 to 1.75 percent. The Fed last raised interest rates in March, by a quarter of a percentage point. It is widely expected to raise them by the same amount at its next meeting in June.

The minutes from the May meeting reported that officials said recent economic indicators “had increased their confidence that inflation on a 12-month basis would continue to run near the committee’s longer-run 2 percent symmetric objective.” But the minutes noted that some officials believed “it was premature to conclude that inflation would remain at levels around 2 percent, especially after several years in which inflation had persistently run below the committee’s 2 percent objective.”

Some officials noted, the minutes added, that “a temporary period of inflation modestly above 2 percent would be consistent with the committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”

As if to drive home the point, the minutes use the word “symmetric” nine times in reference to inflation. Two additional references are found in the statement the Fed released after the May meeting, which noted that annual inflation “is expected to run near the committee’s symmetric 2 percent objective over the medium term.”

Analysts have largely seen the inclusion of “symmetric” as an indication that Fed officials would be willing to tolerate inflation running slightly above target for a period of time. Researchers at Morgan Stanley said this week that in reading the minutes, they would “pay careful attention to the discussion behind the upgraded language” on inflation.

The Wall Street Journal, meanwhile, sees signs of a June rate increase on the horizon, while CNBC emphasizes the point that the Fed is willing to let inflation trend a little higher than it had previously considered:

Federal Reserve officials would be content to let inflation briefly run above their 2 percent target as the economy continues to recover, according to minutes from the central bank’s most recent meeting.

Following the May 1-2 session, the policymaking Federal Open Market Committee said it wasn’t raising rates yet but added the word “symmetric” to describe its inflation goal. Market participants since have puzzled over what the change in language might imply.

The summary released Wednesday indicates a substantial level of debate over how the Fed should approach inflation. The minutes also pointed to an interest rate hike at the June meeting amid debate over how close the Fed might be getting to the end of this rate-hiking cycle.

While the general sentiment was that inflation would continue to rise toward the 2 percent target, there was disagreement over how confident the Fed should be after years of undershooting, and what that would mean to policy. However, there seemed to be agreement that after years of subpar growth and low inflation, allowing the economy to rev up a little would be appropriate.

“A few participants commented that recent news on inflation, against a background of continued prospects for a solid pace of economic growth, supported the view that inflation on a 12-month basis would likely move slightly above the Committee’s 2 percent objective for a time,” the minutes said. “It was also noted that a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”

(…)

On the economy, committee members said their opinions had changed little as they expect continued progress despite some signs of softening in the first quarter.

There was concern expressed over trade and fiscal issues, with Fed business contacts expressing “concern about the possible adverse effects of tariffs and trade restrictions, including the potential for postponing or pulling back on capital spending.”

The outlook otherwise was positive.

“They noted a number of economic fundamentals were currently supporting continued above-trend economic growth; these included a strong labor market, federal tax and spending policies, high levels of household and business confidence, favorable financial conditions, and strong economic growth abroad,” the minutes said.

As things progress, “further gradual increases” in rates would be possible without disrupting the recovery and while sustaining the “symmetric” inflation goal.

Given the economic statistics that we’re aware of, it’s hard to disagree with the Federal Reserve’s evaluation here. To put it in the best possible terms, the economy appears to be staying in the same state of stable but not impressive growth that we saw during the later years of the Obama Administration. Gross Domestic Product growth in the first three months of the year, for example, beat expectations in the first estimate released last month but was still a rather unimpressive 2.3% with little indication that we’re anywhere close to meeting the above 3% growth targets that the Trump campaign and the Republicans on Capitol Hill said would follow from their policies such as deregulation and the tax cut passed in November. Similarly, the Jobs Reports that we’ve seen so far this year, and over the course of the past year, have been largely consistent with the past five years, meaning that they’ve been steady but hardly impressive. As I noted in connection with the April Jobs Report, for example, net job growth has averaged just over +207,000 jobs per month for the past three months, roughly +199,000 since the start of the year, and +169,000 jobs since the start of the Trump Administration. More importantly, while the top-line unemployment rate has fallen during this period to points unseen since before the turn of the century, wage growth has been tepid at best, indicating that employers are seeing little need to raise wages to attract or keep wages. This is significant for economic growth because it means that consumer spending is unlikely to see huge growth if people don’t have more cash on hand.4

In any case, what this all means is that even under the new leadership of Jerome Powell, who replaced Janet Yellin as Chairman earlier this year, the Federal Reserve remains committed to its previously announced plan to steadily raise rates which began back in December 2015. Since that time, the Board has raised rates less than two percent, and that it has done so at a pace that seems designed to have as limited a “shock” impact on the economy as possible. Additionally, the minutes indicate that the Board is expecting that the economy will grow at the same moderate but positive rate that we’ve seen going back to 2013 or so for the foreseeable future. Barring the possibility that economic forecasts and statistics start taking an unexpected dip or heating up unexpectedly, or that financial or other developments in the world don’t take an unexpected turn, we’re likely to continue seeing these occasional interest rate increases for the foreseeable future. With that in mind, a rate increase in June, followed by another one in either September or December or both, seems like the most likely path forward for the Fed. If they stick to that plan, then the economy should continue at its current pace, which isn’t as good as it probably could be, but better than nothing.

The one unpredictable element for the Board, and for the rest of us, of course, is the current occupant of the White House and the impact that his rhetoric and his policies could potentially have on the economy. The President’s rhetoric on trade policy, for example, along with his imposition of tariffs on aluminum and steel, as well as the beginning of what looks like it could be a trade war with China, has sent the stock market spiraling downward on a regular basis. Additionally, these tariffs have had a real impact on the economy as many American companies that rely on aluminum and steel for manufacturing have reported that the price increases that have resulted from the policy are hurting their bottom line. Additionally, the tariffs against China, which China has retaliated for, have already had an impact on America’s agriculture industry, which relies heavily on international trade as a source of business and revenue. In addition to the tariffs, other potential policies from Congress and the Trump Administration on everything from passing the Fiscal Year 2019 Budget to the impact of the tax bill and the possibly never-to-come infrastructure funding. All of those programs would have an impact on the national debt, which in turn would have an impact on the cost of borrowing in the future and, in addition, could make further Congressional action more difficult if it means that we see a return of the deficit hawks.