The Federal Reserve continues to change the criteria for raising interest rates, which in turn creates increasing uncertainty and signals that all is not well with our economy.
When the Federal Reserve began implementing emergency measures to stabilize the U.S. economy, it stated that it would stop these measures once unemployment decreased to 6.5% and inflation increased to 2%.
Unemployment was below 6.5% in April 2014 and currently stands at 5.1%. It has steadily declined from a high of 10.0% in October 2009. It reached its goal of being under 6.5% 17 times since quantitative easing started in November 2008.
Inflation reached a high of 3.87% in September 2011 and has been steadily declining to a current 0.2%. It reached its goal of 2% or more 26 times since quantitative easing started in November 2008.
Both the Federal Reserve’s unemployment and inflation goals were met concurrently both May and June of 2014. But instead of raising rates, the Federal Reserve stated that the 6.5% unemployment rate goal was “outdated” and it has been lengthening the goal posts ever since. Fed Chair Janet Yellen hinted that the goal might be as low as 4.0%.
The opposite has happened with the inflation goal. On one hand, Chair Yellen believes that inflation will increase from its current 0.2% to almost 2.0% before the end of the year and therefore warranting a rate increase.
On the other hand, as inflation has decreased from 2% to actual deflation from January to May of 2015, the Federal Reserve has been talking more about core inflation (inflation minus volatile food and energy prices) instead of its original goal of general inflation. This has had the impact of shortening the goal posts.
The result of these moving goal posts and unclear goals is increasing uncertainty. Its most visible impact is in the increased volatility in the stock market.
It also sends a clear signal that our economy continues to be in a state of emergency. The accommodative monetary policies of bond buying and zero interest rates were sold to Americans as emergency measures to help stabilize the U.S. economy. There continuation means that our economy has been in a state of emergency for almost 7 years. Chair Yellen even confirmed this by stating that the U.S. economy is too fragile to withstand the normalization of interest rates, even with a slow ramp up over many years.
It seems that the Federal Reserve finds itself in between the rock and a hard place it wanted to avoid. Namely, raise rates too soon and hurt the economy or raise rates too late and risk hyperinflation. All the while knowing that zero rates are distorting the markets and misallocating capital the longer it stays in place.
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