Meeting minutes show Fed rate hikes surely on the way

Meeting minutes show Fed rate hikes surely on the way
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The Federal Reserve released the minutes from the Jan. 30-31 meeting of its decision-making Federal Open Market Committee (FOMC) on Wednesday.

The minutes provide a closer look at the Fed’s thinking, giving both staff views and a summary of the comments made by members of the committee. In other words, the minutes tell us a bit more about what was on the FOMC’s mind when it made its decisions three weeks ago.

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The Fed’s discussions are always couched in careful, precise language. In this linguistic field of grey, the assertion that the economy has “substantial underlying momentum” shines with color. The assessment offered by staff and voting members clearly sees the current economic picture as bright.

 

Strong consumer demand, rising personal incomes and solid business investment all have contributed to a strong economy. Economic expansion outside the U.S. has also supported the U.S. expansion.

Central bankers, however, often find reasons for concern when they hear such good news. Since the Fed sees its role as “taking away the punch bowl just when the party is getting good," FOMC members habitually attune themselves to signs that the economy’s momentum might get out of hand, causing increased inflation.

The FOMC discussed staff reports about the relationship between inflation and economic activity. This re-examination was no doubt occasioned by the fact that inflation has stayed so low despite the decline of unemployment to levels that most FOMC members believe to cause increased inflation.

The summary of these reports and their discussion suggest that FOMC members continue to believe in the “Phillips curve,” which connnects lower unemployment with higher inflation. Such a fundamental economic relationship cannot be abandoned lightly.

A number of explanations were advanced for the persistence of low inflation despite low unemployment. One idea is that inflation is simply less responsive to unemployment now than it was back in the 1960s and 1970s when the Phillips curve gained widespread acceptance.

Greater competition both domestically and internationally, the decline of unions and of worker bargaining power and the rise of new market structures involving large-scale networks, might explain this.

Another idea, possibly complementary to the first, is that a series of transitory factors have depressed inflation. Low energy prices, namely, low oil prices, are the most obvious culprit. The majority view on the FOMC seems to be that these transitory factors are gradually dissipating.

However, there were skeptical voices. Notably, while oil prices have increased, the fact that many producers such as the U.S. shale oil firms are able to jump into the market when prices rise, may prove a long-lasting moderating factor.

Finally, some participants argued that there still is slack in the economy despite the low overall unemployment rate. While many of the Fed’s districts reported very tight labor market conditions, some did not. The degree of slack in the labor market has been extremely difficult to gauge during this recovery.

Economists have had great difficulty parsing out the short-term changes in the labor market — many people gave up looking for work but still might be willing to take a job in the future — from the long-term demographic shifts lowering overall labor-force participation.

More retirements were expected as the baby-boomer generation aged, but a whole host of factors have made it unclear whether people are truly retiring or just out of work for an extended period.

If there still is slack in the economy, the Fed would not need to worry as much about rising inflation in the near term. Eventually, strong economic growth would use up the remaining slack, leading the Fed to raise interest rates, but there would be less urgency about raising rates.

Another question in FOMC participants’ minds is whether inflationary expectations are growing. If there were indications that the public is anticipating higher inflation, the Fed would be much quicker to move to raise interest rates and tighten monetary conditions.

However, some participants have been struck with the persistence of expectations of inflation below the Fed’s 2-percent target. These participants worry that such expectations are signs of a deep-rooted pessimism that could perpetuate sluggish economic growth.

The report did note that the stimulative impact of the new tax bill has been a little stronger than expected. On the whole, both staff and participants seemed to feel that the economy had slightly exceeded expectations recently.

However, it is worth remembering that this meeting occurred just before the stock market correction of early February. The Fed generally does not put very heavy weight on stock market developments, but still, they could change the tone a little bit.

Looking forward, the minutes make the clear that the FOMC sees an economy that is heating up. Further increases in the federal funds rate are certainly on the way. There are novel and puzzling economic developments that cloud the Fed’s crystal ball, but no one ever said that being a central banker was be easy.

Evan Kraft specializes in the economics of transition, monetary policy and banking issues. He served as director of the Research Department and adviser to the governor of the Croatian National Bank.