For the first time in nearly a decade, the Federal Reserve is thinking about raising its base interest rate. The Federal Reserve has kept its benchmark interest rate at zero for the past seven years in hopes of spurring faster growth. So far, the central bank has been disappointed.
The stewards of the nation’s economy will gather in Washington this week to decide whether to start pulling back their support of America’s economic recovery. The Federal Reserve has kept its benchmark interest rate at zero for the past seven years in hopes of spurring faster growth.
So far, the central bank has been disappointed.
Will this be the meeting where that all changes? Probably not.
Here are five charts that explain why it’s safe to bet the Fed will pass on raising rates this week. Sure, there will likely be at least one key official who will argue that the time to act has already passed.
But there is growing doubt, both inside and outside the central bank, that the economy will be strong enough to stand on its before the year is over. This week’s gathering appears to merely be a staging ground for the real battle in December, the Fed’s last meeting of 2015.
[Economists are seriously talking about the risk of a new recession]
1. Inflation, where art thou?
The Fed has two missions: to ensure as many people are working as possible and to keep inflation low and stable. Economists generally see these two responsibilities as deeply connected. Falling unemployment is a sign of a strengthening job market and a grooving economy.
Eventually, businesses will have to pay more for new hires, who will then have more money to spend, allowing businesses to bump up their prices. Inflation rises, and the Fed increases its benchmark rate to make sure things don’t get out of hand. It has set a target of 2 percent inflation as a sign of a healthy and balanced economy.
But this recovery hasn’t followed the textbooks. As unemployment has fallen, the chart clearly shows, so too has inflation. Not only that, but it has gotten particularly low over the past year, right as the jobless rate is closing in on what economists had thought was the lowest sustainable level. There are several explanations for why this is happening, some of which we’ll dig into below. But the bottom line is that the Fed is missing its inflation target — and by quite a lot.
2. The growing trade deficit
One of the factors weighing on inflation is the strong U.S. dollar, which is up about 14 percent over the past year against a broad basket of other currencies. A stronger dollar makes American exports less competitive in the global marketplace, and Goldman Sachs estimated that is dragging down U.S. growth by a full percentage point right now.
Even though the dollar peaked in the spring, the brunt of that change is being felt now and will continue through the first half of next year, according to its estimates. But peering through this fog of uncertainty is difficult, and some Fed officials have indicated that they want tangible evidence that inflation is starting to pick up before they will support phasing out the central bank’s stimulus.
[Is there a rebellion at the Federal Reserve?]
3. Stagnant wages
This is the wrong chart to look at if you want to be reassured that inflation will eventually pick up. The unemployment rate is nearly half of what it was in 2010. But wage growth? It’s stayed stuck at about 2 percent. Wages don’t always rise with inflation, but a pickup in household earnings would mean a lot — not only to economists, but to the workers who feel like the recovery has yet to reach them.
4. The slowdown in China and emerging markets
China announced last week that its economy is growing at a 6.9 percent annual rate, just shy of its target of 7 percent. That’s significant not only because it means the country that had been the engine of global growth is sputtering, but also because its leaders admitted it. Still, many economists believe the official data remains too optimistic. Estimates of actual GDP are as low as 3 percent.
And it’s not just China that’s affected. The rest of the developing world, whose growth had outpaced advanced economies, is also growing sluggish. The best case scenario is that countries such as American and England can pick up the slack. The worst case is that the slowdown overseas infects the U.S. as well, throwing the recovery off track. Fed officials want more time to evaluate which way the global winds are blowing.
5. No one is expecting it
The Fed often asserts that it doesn’t make decisions based on market expectations or reactions — and that is mostly true. But it’s also true that the central bank doesn’t want to unnecessarily unnerve investors. So though they don’t always see eye to eye, there’s probably a good reason the market believes there is a 94 percent chance that the Fed does nothing when it meets this week, according to futures markets. And that can become a self-fulfilling prophecy.
If investors are not expecting a rate hike, a surprise could result in some pretty ugly volatility. (We’re looking at you, Taper Tantrum.) On the flip side, you would expect Fed officials would do a better job communicating that a rate hike is imminent when they are ready to make a move — especially one that has been this closely watched.
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