Are We Headed for Another Bust?
On Wednesday December 16, 2015, Federal Reserve Bank policymakers raised the federal funds rate target by 0.25 percent to 0.5 percent for the first time since December 2008. There is the possibility that the target could be lifted gradually to 1.25 percent by December next year.
Fed policymakers have justified this increase with the view that the economy is strong enough and can stand on its own feet. “The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident the inflation will rise over the medium term to its 2 percent objective,” the Fed said in its policy statement.
Unwarranted Optimism
Various key economic indicators such as industrial production don’t support this optimism. The yearly growth rate of production fell to minus 1.2 percent in November versus 4.5 percent in November last year. According to our model the yearly growth rate could fall to minus 3.4 percent by August.
Although the yearly growth rate of the CPI rose to 0.5 percent in November from 0.2 percent in October according to our model the CPI growth rate is likely to visibly weaken.
The yearly growth rate is forecast to fall to minus 0.1 percent by April before stabilizing at 0.1 percent by December next year.
So from this perspective Fed policymakers did not have much of a case to tighten their stance.
Fed policymakers seem to be of the view that the almost zero federal funds rate and their massive monetary pumping has cured the economy, which now seems to be approaching a path of stable economic growth and price stability, so it is held.
With this way of thinking the role of monetary policy is to make sure that the economy is kept at the “correct path” over time.
Following in Greenspan’s Footsteps
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