Of course they could. But should they? Will Yellen do it?
Federal Reserve Chair Janet Yellen in a speech in Providence, RI on Friday, May 19, said, “The economy is still recovering from the Great Recession.” She added that only now, six years after what she said was the end of the recession, is the labor market approaching its full strength. Note the word ‘approaching.’ We are not quite there yet.
So is it time for the Fed to finally raise interest rates?
As anyone who has followed economic policy over the last 7 or 8 years knows, the main push to the economy has been from monetary policy. To rescue the economy from the disaster of 2007- 2008, the Federal Reserve has followed a policy of keeping interest rates at or near zero. The actual interest rates most of us pay on credit purchases have been above zero, but if we factor in the thankfully ever so small increases in the prices of things we buy, the real interest rate has been very near zero.
Many economists would have wished that monetary policy could have had more help from the fiscal side of things, i.e., some help from government budgets, especially with more federal government spending on badly needed infrastructure, especially when the federal government could have borrowed to finance such at the very low interest rates that the Fed had engineered. While consumer demand was wavering, businesses were in no mood to increase investment to boost output, so there was little risk that government spending would simply replace business investment spending, a danger that some conservative economists will sometimes claim.
But help from government budgets was not forthcoming, and monetary policy had to do the heavy lifting. It has been a long, slow slog back to economic normalcy. And there has been much economic misery created in the wake of this painfully slow recovery. As of April this year, the seasonally adjusted unemployment rate for the nation was still at 5.4 percent, almost a full percentage point higher than it was in June 2007.
So should the Fed raise interest rates this year? One thing the Fed has to be cautious about is inflation. Keeping interest rates low as the economy does approach its full employment level runs the risk of setting off inflation. The sequence would go something like this. As unemployment falls, businesses begin to find it harder to find and keep workers, they begin to raise wages to attract labor, their competitors follow suit, as wages rise, families begin to spend more. Businesses then need to add to inventories, bidding up prices and voila, we can find ourselves in a wage, price spiral leading to full blown inflation and all the problems that can bring.
But hold on. At the moment there is almost no sign of inflation. As of the first quarter of 2015 there is no uptick in core inflation. Real average hourly earnings of production and nonsupervisory employees is lower now that it was in October 2010. The unemployment rate is still significantly above 4.5 percent. The European economy is still in trouble, meaning Europeans are not likely to increase their buying American any time soon, and growth in China is slowing down.
We have some wiggle room here. Let’s hope the Fed waits until it is clear that we really are heading for a robust full employment economy before making any rash move.