WASHINGTON–Federal Reserve policymakers are now operating in a “new abnormal,” according to one analysis.
The Fed’s recent announcement that it will likely not raise rates in 2019 and may do so only once through 2021 indicate expectations the days of on-target inflation, full employment and interest rates that, while lower than in decades past, would still need to rise into growth-restricting territory to keep things on track, are not going to be met, according to an analysis by Bloomberg.
As CUToday.info reported, the Fed is now signaling expectations for a slowdown in the economy, which would translate into higher unemployment than previously forecast, and that they no longer expect inflation to rise above their 2% target.
“The move was a serious about-face,” noted Bloomberg, observing there is a “longstanding view in the economics profession about how the economy works: If central bankers allow the unemployment rate to fall too far below its lowest sustainable level by keeping rates too low, then inflation will rise. But in the U.S., though the unemployment rate has fallen to 3.8%, near the lowest levels in five decades, neither price gains nor inflation expectations have gone up. If anything, they’ve been sliding. And it appears to be a global problem. The apparent contradiction has policy makers rethinking things.”
Five Pieces of Dilemma
According to Bloomberg, there are five key developments that explain the “Fed’s dilemma,” including:
- Fed officials’ have been trying to get rates from just above zero -- where they’d held them from 2008 to 2015 -- to their estimate of the neutral rate. But what is neutral now? The Fed now indicates that rate may be 2.75.
- Don’t Look Down. Low rates globally mean central banks including the Fed have less firepower to counter an economic slowdown, stated Bloomberg. “The yield on 10-year Treasury securities, at 2.54%, is only about a tenth of a percentage point higher than the Fed’s overnight rate. Some economists view the Fed’s tightening cycle as now having peaked, and investors see more chance of a rate cut over the next year than a hike. That has Fed officials thinking harder about strategies to deploy alongside rate cuts when the next downturn hits.”
- Price Problems. Low inflation has been a thorn in the Fed’s side throughout this expansion, and it’s a big part of the reason that the central bank has cut back its rate-hiking plans for the cycle, stated Bloomberg. “Fed officials say they target 2% inflation symmetrically -- meaning they’re equally unhappy about overshoots and undershoots -- but they’ve been on the low side since they formally adopted that target back in 2012.”
- Useless Guide. The job market has consistently surprised the Fed. America’s unemployment rate has fallen to less than 4% from 10% in 2009. Despite the decline, employers have found plenty of workers to hire, generally keeping job gains strong, and inflation has responded only weakly, reported Bloomberg.
- Big Balance Sheet. The Fed’s balance sheet exploded to $4.5 trillion from $1 trillion on the back of three rounds of post-crisis bond-buying. “The policy committee has gradually shrunk it to just under $4 trillion by allowing bonds to mature without reinvesting the proceeds. Fed Chairman Jerome Powell and his colleagues announced this week that the rolling-off process will start to slow in May and will end in September,” pointed out Bloomberg.