Federal Reserve indecision about when to raise interest rates exposes what a big mess the U.S. economy is in.
When the Fed employed extraordinary emergency measures to stabilize the U.S. economy after the Financial Crisis, those measures were supposed to end when the unemployment rate decreased to 6.5% and inflation reached 2%.
Unemployment has gone down to 5.2% but inflation has gone from 1.7% in 2014 to 0.2% recently, mostly due to volatile food and energy prices. GDP plods along at a mediocre 2.1%.
As a result, the Fed has been having trouble deciding when to start raising interest rates.
That exposes some huge problems.
First, it shows that the Fed missed its window to raise rates in 2014 when the economy met the unemployment goal and slowly increasing inflation nearly met the inflation goal. Now with energy prices are unlikely to rise substantially, it appears that inflation will remain under goal for a while. That puts the Fed in a bind.
Second, the mixed results of the U.S. unemployment and inflation rates might be bad enough to cause indecision by the Fed but those numbers are positively stellar compared to the rest of the world. With the global economy tanking and U.S. growth increasingly fragile, the key question is whether the relatively independent U.S. economy will get dragged down.
Third, the Fed’s extraordinary emergency measures were meant to stabilize the economy, not bring it back to full health. By keeping these measures in place after the economy has stabilized instead of letting the market do its work has created unintended consequences: the misallocation of capital and the stock market’s dependence on Fed stimulus.
Fourth, the Fed is focused on the here and now instead of the future. Paying inordinate attention to current data, when to raise rates, and being sensitive to stock market movements, the Fed is not spending the time and effort it should on where the economy needs to be in 3 to 5 years.
Fifth, by not normalizing interest rates, the Fed is enabling the dysfunction between the president and Congress. Monetary policy was never meant to act alone in managing the economy. Its partner is fiscal policy, which has been MIA the past seven years.
There are several dilemmas the Fed faces now. Raising rates too quickly will tank the U.S. economy. Waiting too long to raise rates will create another financial crisis. And there are very few tools left in the Fed toolbox when it faces the consequences of imperfect timing.
Prepare for volatility and uncertainty ahead because unlike fine wine, these problems do not get better with age.
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