For most, the Fed’s decision to raise interest rates on Wednesday for only the third time since the financial crisis began was a foregone conclusion. Before the announcement, markets pointed to a more than 95 percent probability of a rate hike, after numerous Fed officials had implied in public speeches that the economy was ready for higher interest rates.
But not all Fed officials felt this way. The release revealed that one person of the Fed’s 10-member open market committee dissented from the decision. On Friday morning, Neel Kashkari, the president of the Federal Reserve Bank of Minneapolis, explained in a statement why his lingering concerns with the economy persuaded him to vote to postpone the rate increase.
In the United States, the central bank is charged with accomplishing two goals — keeping inflation near a target level, which is currently 2 percent, and getting the economy to full employment, a level where nearly all Americans who want jobs can find them. Kashkari, who previously ran for governor of California and helped the Treasury Department manage bank bailouts during the financial crisis, says the U.S. doesn’t appear to be meeting either one of these goals quite yet.
“The key data I look at to assess how close we are to meeting our dual mandate goals haven’t changed much at all since our prior meeting,” when the Fed voted unanimously to hold rates steady, Kashkari wrote. “We are still coming up short on our inflation target, and the job market continues to strengthen, suggesting that slack remains.”
Inflation has picked up since the Fed’s last meeting Jan. 31 to Feb. 1, as the chart below shows, but that’s almost entirely due to a recovery in previously ultralow oil prices — trends which could disappear just as easily as they arose.
Jobs data is also suggesting the economy may have some way to go before it needs higher interest rates, Kashkari says. When there’s still slack in the labor market, in the form of people who are not ideally employed, looser monetary policy encourages businesses to expand and hire new people. But once those economic resources are all used up, lower interest rates just translate into inflation.
One of the big surprises over the past 18 months is that the job market continues to be so strong, able to pull people back into the labor force who gave up looking for work altogether, Kashkari wrote. The United States added 235,000 jobs in February, official data show, far above the level needed to keep up with population growth.
“This surprised us a bit because it suggests that there were many more people who were interested in working than historical patterns predicted,” he said.
Other measures of employment still remain below where they were before the recession, as the chart below shows, and may have room to grow.
Economists are divided on these points. The Fed’s decisions take time to work their way through the economy, and some feel that it’s past time for the central bank to move to head off inflation. They worry that holding rates low could be inflating dangerous asset bubbles — like the too-high housing prices that sparked the Great Recession — or that the Fed could fall dangerously behind in its mission to fight off inflation.
“They are going to have to start raising interest rates,” said Steve Rick, chief economist at CUNA Mutual Group. “The labor market is looking really tight across most of the country.”
“The Fed could be crossing the Rubicon here from going from an economy that had slack to overheating if they don’t start raising rates now. Inflation could be coming a little quicker than we thought with the tight labor market,” Rick said.
But others disagree. In a blog post Wednesday, Josh Bivens of the Economic Policy Institute called the Fed’s decision “disappointing” but “not surprising.”
“Today’s hike seems to signal that Fed policymakers think that we’re currently at or very near full employment, and that failing to slow the pace of economic growth in coming months would soon lead to accelerating wage and price inflation. They could be right, of course, but it is important to note that there is little in actual economic data to indicate this,” Bivens wrote.
One risk in delaying interest rates is that it could force the Fed to move more quickly later to offset inflation, the kind of rapid change that some economists believe could destabilize the economy. Fed chair Janet L. Yellen has repeatedly pointed to this as a risk the central bank would like to avoid.
But Kashkari and others claim the danger isn’t in having to raise rates quickly — it is being put in a situation where rates are higher than central bankers would want.
The central bank can increase rates relatively easily. But with interest rates currently so close to zero, it doesn’t have much room to cut rates further to stimulate the economy — perhaps a worrying sign in a global environment where deflation still appears to eclipse inflation as the biggest risk.
“From a risk management perspective, we have stronger tools to deal with high inflation than low inflation,” Kashkari said.