The Big Question for the Fed This Week: Did We Make a Mistake?
S E E D E D C O N T E N T
Central bankers pride themselves on being the grown-ups of economic policy.
Jerome Powell, the Fed chief, has told colleagues not to make policy just to prove their political independence.
Brendan Smialowski/Agence France-Presse — Getty Images
But what if the grown-ups make a mistake? This week, at a two-day policy meeting ending Wednesday, Federal Reserve policymakers will, implicitly, be discussing whether they’ve raised interest rates too much, too soon.
The way things have evolved in the last few weeks, both in financial markets and in the economic data, it increasingly looks as if the Fed’s four rate increases last year pushed the cost of borrowing money beyond the level that the current U.S. economic fundamentals can sustain.
The question for the Fed is whether to correct a possible mistake by cutting interest rates, or to leave rates where they are and hope that things turn around. The optimistic view is that a sharp drop in Treasury bond yields and some soft data on factory output, job growth and wages reflect just a temporary blip.
The economy still seems to be growing steadily, and the unemployment rate is very low. This is far from a crisis. But wages are rising more slowly than they were a few months ago, and the forecasts for inflation and growth reflected in bond prices have plummeted in recent weeks. That is the case despite new tariffs on Chinese imports that should push consumer prices up over time.
New developments on Friday confirmed the pattern. The University of Michigan consumer sentiment survey showed Americans’ expectations of future inflation fell to 2.2 percent, the lowest on record, from 2.6 percent in May. And the prices of inflation-protected bonds implied that investors’ expectations of inflation over the coming decade fell to 1.65 percent, the lowest in nearly three years.
The yield curve , which charts the interest rates the government must pay to borrow money for short versus medium versus long periods, tells a story about what savvy big-money investors see as the most likely economic future.
Right now it is indicating that the economy is slowing, that the Fed will need to cut interest rates significantly in the next few months, and that it won’t need to raise them again for a few years. Moreover, it’s hinting that both interest rates and inflation will stay quite low by historical standards for decades to come.
All of that suggests that the Fed raised interest rates too much in 2018, and that the economy isn’t strong enough to sustain the interest rate target of just under 2.5 percent (where things stand now).
In effect, if you believed that the interest rate target was set correctly a couple of months ago, as Fed officials did, it is hard to believe that is still the case given the combination of falling longer-term interest rates, inflation expectations and softer growth in job creation and wages.
The consensus view of savvy Fed watchers is that the central bank won’t actually make a major reversal in policy this week, but will signal openness to doing so at future meetings. And Jerome Powell, the Fed chairman, and his colleagues may first want more information — particularly from a potential meeting between the presidents of China and the United States at the G20 summit later in the month, which could calm trade tensions.
But the nature of economic policy is that you’re always making it in a fog. And there is cost to waiting, too — a message that the Fed just isn’t too concerned by the signs of an economic slump that are evident in markets and some economic data, like recent surveys of factory activity and the most recent employment report .
You don’t have to be a psychologist to think that some Fed officials may be reluctant to cut rates because it would either look as if they were concluding that President Trump was correct in his attacks on their interest rate increase in December or bending to his demands for rate cuts.
Mr. Powell has told colleagues they need to ensure they don’t make bad policy just to try to prove their political independence — that they need to make the same decisions they would make absent presidential pressure. The coming meeting will be a test of that resolve.
There are solid arguments against raising rates just now, involving financial stability. In particular, if the Fed reacts too quickly to the tribulations of financial markets, it could encourage excessive risk-taking in ways that could ultimately fuel a boom and bust.
On the other hand, if Fed officials refrain from cutting rates this summer and the economy falters, they are almost certainly likely to end up with even lower rates for longer in trying to repair the damage. If you believe low rates inevitably fuel financial excess, a small rate cut now may be better than big rate cuts later.
There is a truism of central banking that if you wait until there is overwhelming evidence that the economy is falling apart, you’re probably waiting until it’s too late. One man’s trigger-happy overreaction to data is another man’s prudent risk management.
The economic expansion turns 10 years old in a couple of weeks, when people flip their calendars from June to July. (That is, unless a recession has begun and we just can’t see it yet.) The Fed has done a lot of hard, frequently unpopular work to keep the economy on track.
Sometimes, being a grown-up means admitting you were wrong.
For the Krugman-is-Satan crowd: he has been saying all along that the hikes were premature.
For the Trump is satan crowd: he has been saying all along that the hikes were premature.
Wow! Krugman agrees with Trump. That musta left a mark on Krugman.
I doubt that Krugman takes much account of what Trump says about the economy.....
Do you have anything to say about the seed?
I doubt Trump cares much of what Krugman thinks either. Unlike you I don't really care for much of what Krugman has to say most of the time either. He's way too biased in my view. But like a a broken clock, he is bound to be right at least twice a day.
So you don't like my contribution?
Then you must be equally disappointed with yours since it said the same thing and came to the same conclusion.
I'm always disappointed when someone is too self-important to bother reading expert opinion I have proposed, before expressing their own inexpert opinion.
Life is full of disappointment Bob and yet ...... life is good if you make it so.
Like i said, if you were disappointed in my response, then you should have been disappointed in yours.
But speaking of self important, i'm sure you are not ..... c'est la vie is what i have to say about that ....
Oh, gosh!
Such scintillating language!
Glad you like it.
Thanks!
Don't you believe it. That's how he makes his living.
If bringing in Krugman (he didn't write the article, after all) is relevant, bringing in Trump should be too.
I think it's actually an important observation that people of opposing political parties are coming to the same conclusions about economic policy. Finding common ground is an important step in overcoming paralyzing partisanship.
Expert opinions are unbiased. Krugman gave up expert opinions a long time ago.
It is well known that facts have a solid liberal bias. Krugman deals in facts. His articles are documented - all those links are there for a reason.
Krugman writes two kinds of article: economics and politics. Economics is no more biased than astronomy. Politics... well... for many years, Krugman's blog title was "The Conscience of a Liberal".
The real reason conservatives dislike Krugman, is that he's far smarter and better documented than they. They never win an argument against him, so they don't try. Character assassination is so much easier than thinking...
If you define "well known" as "oft repeated among liberals in desperate attempts to cover the fact their math doesn't work"...then OK, maybe.
If he dealt in facts, he would have a news column, not an opinion column.
No he doesn't. He writes political blog posts. He takes the liberal shiny object of the day and tries to justify it using some sort of economic rationalization.
Riiiiight. Because Keynes and Friedman agree completely. Seems odd then that Krugman should give so many column inches to opposing conservative economists.
I'm not sure why he bothered to change it.
I'm sure you have convinced yourself this is the case. You have also convinced yourself that Bernie's math works and that AOC doesn't act like she's in high school.
Fortunately for all of us, checks and balances generally keep people like Krugman from having any real influence.
I never said that.
Please fix your comment.
First it is important to understand that the Federal Reserve does not make economic policy. The Fed controls monetary policy which is only one component of economic policy. The sphere of the Fed's influence is limited to the financial sector. The Fed exerts control over how much the financial sector can scrape off the real economy.
Economic policy consists of an aggregate of monetary, fiscal, tax, regulatory, and trade policies. While too early to tell, the performance of the real economy may be indicating less dependence upon monetary policy as the preeminent indicator of future economic activity.
What the article is alluding to is that the banking sector is facing head winds. The Federal business tax cuts freed a lot of internal cash and businesses, in general, are not as dependent on begging for money from the financial markets. And increased employment and wage increases lowers consumer dependence upon credit. Sustained wage growth would make that a feature and not a flaw. The result is less competition for credit and a shift toward savings to support consumption. Using savings to support consumption tends to heighten aversion to risk.
The more aggressive trade policy should spur investments in domestic production. However, uncertainty over the Federal government returning to an essentially unregulated open-border trade policy would make those domestic investments very risky. The Federal regulatory environment really does increase the costs for domestic industrial investments while at the same time the Federal government support for weak trade policy greatly increases the risks associated with domestic industrial investments. The status quo economic policy of the Federal government has been a double whammy that favors the preeminence of monetary policy. With the Federal government as a friend, the industrial sector doesn't need more enemies.
Actually... It does.
Only in Milton Friedman's dreams. The preeminence of monetary policy is key to supply-side economics. That's how non-producers and middle men exert control over the economy.
The fundamental purpose of an economy is not to create money. But that is precisely what the Fed regulates.
This is ignores the more important question. When will disband the Federal Reserve control over our monetary system and their control of the economy
Every advanced country has a central bank. It is a necessary function. Suggesting it should be eliminated is just plain stupid.
giving 5 bankers control over our monetary system cannot find support in the Constitution
yet the left who despise banks are happy letting these banks control our money and economy.
if you want a Central Bank, let Congress create one as an arm of the US Treasury
but I don’t find a private central bank here in the Constitution
from Article 1, Section 8
”To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;”
Do you have a particular complaint, or is this the shotgun approach?
No institution is perfect, so if you have suggestions for improvement, that's worth debating. But you said "disband", and that would be stupid.
Th Federal Reserve does not serve the best interests of our nation and was not Constitutionally authorized.
What do you mean?
- That the Fed fails in its missions?
- That the Fed serves the best interests of some other entity?
You present no support/evidence for either supposition.
So?
Perhaps. But allowing the private sector, alone, to control monetary policy would be disastrous. How many panics, recessions, and depressions were started by government? There were panics and deep depressions before the Federal Reserve was established. Also remember the Federal Reserve is really not a government institution but rather a private institution subject to more stringent government oversight.
Politicizing the monetary system isn't a solution. Political abuses of monetary policy (primarily concerning the bimetallic reserve as a means for providing political favors) is why the Federal Reserve was established.
True the Federal Reserve is not a perfect solution. But it is certainly better than when political government had sole authority over monetary policy. If Congress is incapable of managing fiscal policy then expecting Congress to provide a rational monetary policy would be an unrealistic expectation.
Someone has to regulate the monetary system, that is unavoidable. And it is important that the responsible institution be politically independent. But equally important is for the responsible institution to be independent from private sector collusion.
Congress cannot manage fiscal policy. Making Congress responsible for monetary policy would create a FUBAR monetary system. That is the one advantage of a metal reserve; the monetary system regulates itself to some extent because of scarcity. But that one advantage also carries with it a host of disadvantages which would be almost impossible to overcome.
A central bank really is a reasonable compromise.
The bigger problem is when monetary policy overshadows other parts of the real economy. Monetary policy (and finance) is only one component of a comprehensive economic policy. The fundamental purpose of an economy is not to create money but that is what monetary policy is all about.
We got by just fine prior to the creation of the Fed in 1913. This video does a great job of explaining what the Fed is and why it was created to protect the banks.
Oooh, a 40 minute rerun from G. Edward Griffin. Is Griffin's cure for the monetary system the same as his cure for cancer? Has Griffin solved the Kennedy assassination yet? And Griffin still has extra time in his busy schedule to be a 9/11 Truther. Griffin is too unreliable a source of information to even be considered a loony quack.
Enlighten us, what happened when banks failed in the 19th century? What role did Citibank play in creating the Federal Reserve? Citibank was originally chartered as City Bank of New York and has been responsible for more panics, recessions, and depressions than any other bank in US history. Citibank is why Glass-Steagall was repealed by Congress. Does G. Edward Griffin receive a stipend from Citibank?
Very true... and difficult!
The best economists are to be found in two places: universities and... banks! Independence is not simple.
Yes, indeed! After all, making an institution responsible for monetary policy does require expertise in the monetary system. That is a naturally (and I argue) unavoidable bias.
A common sense remedy would be to disperse the disparate components of economic policy across institutions. The problem arises when one component of economic policy greatly overshadows the others. The functioning of our government is based upon the idea of checks and balances to avoid concentration of power in any one institution. The big policy areas of finance, industry, trade, regulation, and taxation counterbalance each other and, as a result, establishes a more balanced economic policy.
We should recognize that the Federal Reserve only regulates the monetary system which one component of economic policy. And we should expect the other components of economic policy to receive as much attention.
The panic of 1873 was a deeper and longer lasting depression than the Great Depression of the 1930s. During the 19th century bank failures were fairly common and a bank failure meant depositors were the losers. The metallic reserve severely restricted credit; the economy was far more dependent upon the wealthy who hoarded gold and silver. The rich became richer by artificially manipulating scarcity of the reserve standard.
So, no, the United States did not get along just fine without the Federal Reserve.
Prior to the Federal Reserve banking losses were absorbed by depositors. The wealthy were protected because they actually owned (and hoarded) the gold and silver that made up a bank's reserve. That allowed the wealthy to manipulate banks by creating an artificial scarcity of the metallic reserve; forcing banks to pay more than the value of the metal to maintain a reserve. The wealthy really did form cartels and colluded with each other to manipulate the monetary system for their benefit.
Claiming the Federal Reserve is a cartel ignores some important distinctions. The Federal Reserve acts as a 'cartel' the same way an insurance company does. Insurance provides a hedge against catastrophic loss that would reverberate throughout the economy. Yes, that does protect those who are covered by insurance by dispersing risk. But insurance also leverages the aggregate economic influence of members to regulate abuses. So, yes, the Federal Reserve does function to protect the banking system but the Federal Reserve also regulates abuses in the banking system that would increase risk.
Never. That would be stupid.
This is probably off topic ... but I enjoyed a book called "Markets, Mobs and Mayhem." It's about fads rather than the Fed, but might interest the folks who are commenting on this thread.