A lot has changed since a new administration took charge on Jan. 20, so the Federal Reserve’s decision last week to maintain its policy rate might seem odd. Punitive new tariffs appear to be imminent, which would likely push prices higher, disrupt the economy and hold back growth. Also in the cards: a big fiscal stimulus, as Congress prepares to extend the 2017 tax cuts. Shouldn’t the central bank take a view on all this and adjust monetary policy accordingly?
No, it shouldn’t. At the moment, uncertainty rules. It’s impossible to say what the White House truly intends on tariffs — a short-term threat to extract border-security concessions, a long-term source of new tax revenue, a wall to shut out foreign manufacturers? (Whatever the administration says, logic dictates that it can’t be all three.)
Fiscal plans for the rest of this year are likewise, for now, a mystery. With the economy at or close to full employment and inflation still inching down toward the Fed’s 2% target, there’s no urgent need to push interest rates one way or the other. Chair Jerome Powell and his colleagues on the Federal Open Market Committee were well-advised to bide their time.
Still, financial markets could glean some interesting signals from the central bank’s policy statement and Powell’s post-meeting news conference. The revised statement says the unemployment rate has “stabilized at a low level” rather than “the unemployment rate has moved up but remains low.” And it now says “inflation remains somewhat elevated,” not “inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated.” These tweaks signal a shift in the Fed’s judgment of the balance of risk — from “the job market is weakening” to “inflation is stubborn.” Hence its view that a gently restrictive stance is still appropriate and that resuming progress toward a more “normal” policy rate should wait.
That does indeed make sense — and not just because of the employment and inflation numbers. Equally important is doubt over the “normal” or “neutral” policy rate. Following the pandemic and the resulting economic distortions, nobody, including the Fed, can be sure what that rate is. New doubts surrounding trade and fiscal policy only complicate things further. The current policy rate might turn out to be the new normal; conceivably, higher, not lower, rates will be required in due course. As things stand, speculation about what comes next doesn’t help. The only sure guide will be incoming data on employment and prices.
At his news conference, Powell sent another message. Courteously but firmly, he asserted that the president’s repeated demands for lower interest rates weren’t a factor in the Fed’s calculations: They hadn’t discussed the matter, he said. The White House would be wise to let the subject rest. If it dents investors’ confidence that the Fed sets policy by its own lights, the result will be a spike in inflation expectations — and higher long-term interest rates regardless of the short-term policy rate. In this new era of confusion over policy, it’s more important than ever that the Fed’s independence can be implicitly assumed.
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