The economy grew at a tepid rate of 1.5% during the third quarter. More than 100 million Americans aren’t working. And the inflation rate is near zero.
That’s after seven years of the most radical monetary policy in history, which was supposed to lower unemployment while boosting the inflation rate to 2%. If you’re the Federal Reserve Board, do you:
- Conclude that keeping interest rates near zero isn’t helping the economy and abandon that policy.
- Keep doing what you’re doing, hoping things will change next year, so you can take credit for it.
- Conclude that the economy is still a mess even after you bought a few trillion dollars’ worth of bonds, so maybe you need to buy more bonds.
When economists think rates will rise.
The correct answer, at least last week, was b., as the Fed voted to continue its zero interest rate policy (ZIRP), “surprising no one,” as The Wall Street Journal noted.
That means the Fed will keep on zirping, at least until December, but more likely into 2016.
Subject to Interpretation
The Fed’s policy statement, which has changed about as much as Fed policy over the past seven years, was interpreted by many to imply that the Fed “might” increase interest rates by a whole 0.25% when it meets in December.
“Before the Fed released its policy statement Wednesday,” The Wall Street Journal reported, “traders in futures markets put about a 1-in-3 probability on a Fed rate increase this year; after the release, that probability rose to almost 1-in-2.”
In addition, nearly two-thirds of economists participating in The Wall Street Journal’s latest monthly survey believe the Fed will raise rates in December. Of course, these are the same economists who have been predicting a rate increase for about as long as The Wall Street Journal has been surveying economists.
Given that the Fed’s policy statement doesn’t even mention interest rates, the interpretation of futures traders and economists is itself open to interpretation. On what do they base their belief that the Fed will increase rates? On the omission of the following sentence from this month’s policy statement:
“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
Has the global economy improved so much during the past month that deflation is no longer a concern? Don’t be ridiculous. Of course it hasn’t. But given that the Fed issues practically the same policy statement every month, the experts parse every word change and interpret its meaning.
However, the Fed has consistently said that its monetary policy is designed to achieve the two goals stated above: low unemployment and an inflation rate of 2%. Remove Americans who have stopped looking for work and include part-time workers as if they are working full-time and the unemployment rate is a respectable 5.1%. But the inflation rate is nowhere near 2%.
Of course, the past seven years have proven that ZIRP has little impact on the unemployment rate or inflation. The net effect of Fed policy has been to artificially boost stock prices, helping the wealthiest Americans, while also ensuring that those who are living on fixed incomes earn nothing on their savings.
But stopping ZIRP before the Fed’s twin goals are met would be admitting that ZIRP’s not working, and so it continues … on and on and on and on and on.
Revising the Inflation Rate
Given that we’ve been writing about ZIRP since this blog began, we’re even more sick of it than the average American, so we’re offering a way out for the Fed. The solution is so simple, we’re surprised that the Fed hasn’t done it yet.
Since the Fed can’t change the inflation rate, why not just change how inflation is defined?
There’s precedence. The way the unemployment rate is reported changed during the Clinton Administration. By excluding those Americans who have stopped looking for work and by counting those who are working part-time as if they are fully employed, the unemployment rate has dropped to 5.1%. It’s still really 11%, but it’s reported by the government, news media and almost everyone else as being at 5.1%.
We wonder how the Bureau of Labor Statistics (BLS) determines how someone has stopped looking for work, but lumping millions of Americans into that category does wonders for the unemployment rate.
Equally ridiculous is the consumer price index (CPI), on which the inflation rate is based; it excludes food and energy prices, even though we all need food and energy to live on. But when you’re cooking the numbers at the BLS, perception is more important than reality.
The Fed measures the rate of inflation based on the Chain Price Index for Personal Consumption Expenditures (PCEPI) rather than the CPI, because the Fed members believe they will look smarter if they use obscure benchmarks with long names.
So why not just change the basis for measuring inflation to come up with a 2% rate of inflation? Maybe exclude energy for now, and overweigh food and healthcare costs. A 2% inflation rate could be achieved immediately.
The idea is absurd, of course, but no more absurd than the policies the Fed has been following for the past seven years.