Behind The Fed's stealth tightening
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The Fed hasn't raised interest rates since last summer. But policy continues to get tighter — even if only slightly. That's putting a harder brake on the economy than some Fed rate-setters might desire.
Why it matters: The quiet tightening provides a case for cutting rates sooner, even if the latest inflation report is not enough to convince central bank leaders that inflation is returning to target.
How it works: When inflation falls while the Fed stays put, the real cost of borrowing goes up. Effectively, that means monetary tightening.
- Fed officials might want to prevent such restrictiveness on the economy, especially given early signs of a slowdown.
What they're saying: "The reason to be tightening in real terms would be if you thought the economy was overheating," Chicago Fed president Austan Goolsbee told reporters in Chicago yesterday.
- "This is not, in my view, what an overheating economy looks like," Goolsbee said. "The reason to tighten should be by choice, not by accident."
- Goolsbee will vote as an alternate at the rate-setting meeting at the end of this month, following the retirement of Cleveland Fed president Loretta Mester.
By the numbers: The Fed's main policy rate is 2.3 percentage points above inflation over the past year, as measured by the Consumer Price Index.
- A year ago, when the Fed last raised rates, the Fed funds rate was 1.8 percentage points above inflation.
The big picture: The risk of lowering rates too late and weakening the economy is just as large as cutting too soon and pushing inflation back up, Fed chair Jerome Powell told lawmakers this week.
The intrigue: "If we're going to stay as restrictive as this — and in fact be, in real terms, tightening — we have to be pretty mindful of both sides of the mandate," Goolsbee said. "It's not going to just be inflation."
- "We're to the point now where additional labor market slowing is more likely to result in a rise in unemployment," San Francisco Fed president Mary Daly, who added that Fed policy was "tight," said on a call with reporters yesterday.
What to watch: Odds are rising that the Fed will lower rates three times this year, according to the CME FedWatch tool. Last week, this looked like a 25% chance. Now, it's over 40%.
- "The committee put out a statement saying we would not anticipate cutting rates until we were more convinced we're on path to 2%," Goolsbee said, referring to the Fed's inflation target.
- "My view is this is what the path to 2% looks like."
The other side: St. Louis Fed president Alberto Musalem said yesterday that monetary policy was not "overly restrictive."
- "I will be looking for more evidence that inflation can be expected to converge to 2% going forward," Musalem said.
