Federal Reserve Should Raise The Federal Funds Rate

The last five years have shown that traditional monetary policies predicated on interest rate management by the Federal Reserve no longer deliver the economic growth they were once believed to. Keynesian economics has proved to not be as effective as once thought, which has led to the Federal Reserve choose alternative means to stimulate the economy and indirectly manage exchange rates (Hakkio, 1986). The uncertainty over interest rate polices has fortunately not led to increases in inflation, which has typically been the case in the past (Kopcke, 1988). The current economic conditions and the approaches the Federal Research are taking however are cause for concern, and from a personal standpoint many decisions are being evaluated more precisely.

1. The Fed should direct the monetary policy of the U.S. In doing so it will, “promote employment, stable prices, and moderate long-term interest rates.” In order to achieve such requests the Fed will have to change the

At last month’s Federal Open Market Committee (FOMC) meeting, Chair Yellen expressed her most upbeat assessment about the near-term path for the US economy by claiming that fiscal stimulus was unnecessary to achieve full employment. Accordingly, unemployment is expected by the FOMC to settle below its natural rate this year. Meanwhile, the current underlying sentiment amongst members appears to suggest that the economy can withstand three 25 basis points increases in the federal funds rate in 2017. This view will, however, not necessarily remain static. In December 2015, for example, the mood of the FOMC appeared to support four 25 basis points increases in its policy rate during 2016. The outcome was,

The US economy was finally taken off extreme life support when the Federal Open Market Committee (FOMC) raised the federal funds target for the first time in nearly a decade at last week’s policy meeting to 0.5%. In contrast to September, when the FOMC shocked markets by failing to raise the policy rate, there were no major surprises embedded in the press statement. The Fed viewed current growth as being moderate due to a solid domestic economy being offset by some external weakness. Meanwhile, outlook risks for growth and the labour market were deemed to be balanced. From the perspective of financial markets, the FOMC conveyed that it did not believe monetary policy was tight. Conditions remain accommodative. The path of future interest rate rises is expected to remain gradual, but this outlook is based on a forecast and is, therefore, not guaranteed. The continuation of monetary accommodation increases the chances of further labour market tightening and inflation eventually returning to the 2% target. The importance of the future path of actual inflation was also stressed. Significant deviation between forecasts and observed outcomes could impact the pace of subsequent policy rate increases. The baseline outlook for Fed policy in 2016 remains unchanged: four increases in the federal funds rate of 25 basis points. Commentators appeared pleased with the quality of the Fed’s communication, particularly given the criticism following the decision

Recently in the news there has been a great deal of talks of the future rises of interest rates in the United States. To understand how the Fed 's own particular figures may change, The Wall Street Journal analyzed how the standpoint among private forecasters had changed since March, when the Fed last upgraded its Summary of Economic Projections. The new 2.1% appraisal is beneath the Fed 's 2.5% projection for March and recommends Fed authorities may be bringing down their own numbers when they discharge their new Summary of Economic Projections at the June 16-17 meeting. After Fed authorities move down their projections for premium rates and monetary development in March, speculators reacted by pushing down genuine rates and the estimation of the dollar. Private investigator gauges for unemployment and expansion are minimal changed, and propose the Fed 's own figures will be stable on this front in its June forecasting round. The levels they see for the rate 0.6% toward the end of 2015, 1.8% toward the end of 2016 and 3% toward the end of 2017 are beneath the Fed 's anticipated way as of March, and recommend Fed projections may edge down modestly as well.

The Fed has, over the past few years, been lowering its estimate of long-term potential real GDP growth. Presently, the Federal Open Market Committee (FOMC) believes the US economy is capable of sustaining expansion of just +1.8% per annum. This estimate is based on two components: 1) anticipated labour force growth of +0.3% pa, and 2) annual productivity increases of +1.5%. Given the Fed’s commitment to its 2% long-term inflation target, this backdrop would consequently imply that wage inflation should be running at around +3.5% when the economy eventually hits full employment. Average hourly earnings have been ticking up recently, thereby confirming that the US labour market is tightening, although the annual increase is still below +3%. There is, however, still some slack in the labour market, as characterised by the “U6” measure of underemployment which is still 150 basis points above its low reached during the previous expansion. Fed Chair Yellen has been prepared to wait until broader measures of labour underutilisation, such as U6, improve further. The luxury of being able to sit pat is, however, now fading. Financial markets now expect the FOMC to raise the federal funds rate at this year’s final policy meeting next month. Meanwhile, the FOMC will still be keen to stress that any subsequent rate hikes will remain gradual. This seemingly benign outcome may, however, be beyond its control: fiscal policy will be eased in 2017,

During these hard times, people are facing one of toughest job markets in our nation’s history. Even though the media says economic recovery is imminent, many are still wondering when they will see the light at the end of the tunnel. The Federal Reserve Bank or FED is already being asked to prepare an “exit strategy” due to the concern that the expansionary monetary policy they used will quickly turn the recession into high inflation. This “exit strategy” can also be described as contractionary monetary policy and is going to be used to counteract the inflation sure to follow the economy’s recovery. Critics of this plan argue about when it should be implemented because it could make a recession worse or the inflation just as bad as the

Leadership at the Fed has, once again, been found wanting. After indicating in her Jackson Hole speech in late-August that the case for a higher policy rate had recently strengthened, Fed Chair Yellen has flip-flopped and sided with the dovish members of the Federal Open Market Committee (FOMC). Her credibility as an effective communicator for the entire FOMC has, therefore, been compromised. Additionally, there are now clear signs of rising dissent amongst FOMC members, something which financial markets will have noted. The 20-21 September policy meeting released updated economic and federal funds rate projections and they indicate that the majority of members expect just one rise in the policy rate in 2016. This constitutes a downgraded assessment since June’s forecasts when two increases were projected. Meanwhile, expectations of rate hikes in 2017 have also been scaled back to two compared with three back in June. Furthermore, the anticipated terminal level of the federal funds rate has been modestly reduced to 2.875% from 3%. Given the continued projection of a long-term 2% inflation target, this implies that potential real GDP growth has been scaled back. The FOMC has duly obliged with a downward revision to 1.8% from 2%. Last week’s meeting concluded with the highest level of dissent since 1992. Fed Chair Yellen indicated that discussion was dominated about the timing of the next rate hike vis-à-vis whether a higher policy rate was

Over the past few years, the Fed had been trying to heal the economy from the recession by lowering the interest rate near zero in order to raise the inflation, increasing the price of housing and household wealth. This will encourage more people to buy products or services, causing an increase in consumers spending. Based on the data given by the U.S. Department of Commerce today, the economy is now healing from the recession with the expansionary monetary policy. However, some people argue that it takes too long for the recovery to happen and suggests that it is time for the Fed to come out with an exit strategy. However, I think the Fed should stick with its policy because it manages to improve the economy. Therefore, I think the Fed

Similar to the United States and as noted by Taylor (2008) and Ahrend and others (2008), In light of these considerations, the evaluation of policy settings is perhaps best done through a comparison of projected outcomes for the policy objectives given policy expectations; such a comparison involves examining whether the forecasts of policymakers, the private sector, or other forecasters were consistent with a balancing of the price stability objective and the full employment objective (for example, the unemployment rate in the neighborhood of its estimated natural rate). This guidance was designed to influence asset prices, economic activity, and inflation in a manner consistent with the goals of price stability and full employment. As has been emphasized by many researchers, the guidance of expectations is the primary channel through which policy affects economic outcomes—the overnight interest rate in the interbank market is in itself in consequential for economic activity, except to the extent that it affects expectations of the future path of this rate, which in turn influence a broad array of asset prices important to aggregate spending and price setting.

The Chairman of the Federal Open Market Committee (FOMC), William Dudley, appeared last week to virtually rule out any chance of an increase in the federal funds target at the 16-17 September policy meeting. As President of the Federal Reserve Bank of New York, he is probably the best qualified member of the FOMC to understand the implications of tightening US financial conditions. That having been said, Mr Dudley was careful not to entirely rule out the case for normalisation, depending on incoming information about the state of the economy. Given the short time horizon between now and the next policy meeting, it would seemingly require significantly stronger-than-expected data to bring September back onto the table as a plausible launching point for a higher policy rate. Meanwhile, Fed Vice Chairman Fischer asserted last Friday that September still remains an option to raise the federal funds rate and that the fallout from China is being assessed. He believes that the direct economic impact from a slowing Chinese economy on the US is modest and that the domestic economic backdrop continues to normalise. This would, therefore, be conducive with a more conventional policy stance at some future point.

There are, however, a number of escape routes for the FOMC to utilise. Firstly, members could aggressively lower their estimate of the natural rate of unemployment, and, secondly, the policy reaction function could be subsequently altered to adjust for the lowered target of this important metric, all other things being equal. Reducing the estimate of the natural rate of unemployment would suggest the economy is currently further away from full employment than originally envisaged. The policy reaction function could, therefore, be adjusted with a dovish tilt, particularly if inflation continued to undershoot the FOMC’s 2% target. Forward guidance to interest rate normalisation would subsequently require revision. Meanwhile, the reluctance of the FOMC to lower their estimate of the unemployment rate or change the policy reaction function from its current hawkish tilt has the hallmarks of a central bank being locked into a somewhat dogmatic path of interest rate normalisation, at least for the time being.

Faster economic growth raises the chances of the unemployment rate dipping further below its natural level, while a depreciating dollar will produce imported inflation. These dynamics cumulatively auger well for the FOMC to retain their current forward guidance. Meanwhile, the issue of potential excessive risk taking in the financial system is somewhat more contentious, given that the last two US recessions were caused by collapsing asset prices producing a significant decline in private investment. Chair Yellen openly admits that US financial markets are somewhat richly priced, while retreating from the current path of forward guidance will consequently raise the risks of further froth emerging. Furthermore, since the financial crisis, the Fed has been charged with the responsibility of providing financial stability to ensure that the real economy is not imperilled should another crisis unfold. The pursuit of so-called macro prudential policies would involve issuing directives about limiting capital deployment in risker business lines. The FOMC would probably be loathed to go down this route due to the risks of inadvertently causing a credit crunch.

From its inception, the central bank’s onus has always been a dual mandate; to maintain maximum employment while at the same time keeping stable prices. While we as economists have learned much about the mechanism through which monetary policy affects the economy, much is still unknown about the inner workings of the economy, and the long-term effects of varying monetary policy. Over the past two decades, the Federal Reserve has dictated that the inflation target rate should be close to two percent for the American economy, yet this idea has come into question in the past 5 years.

The July FOMC minutes [http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20150729.pdf] first raised doubts about this view, highlighting how the recovery might be incomplete, due to slowing global growth, while financial conditions have tightened due to the China-led equity sell-off. At that meeting, almost all members would need more evidence to be reasonably confident in the inflation outlook’s improvement.