The information received by the Federal Open Market Committee (FOMC), since its meeting in January, has shown signs of further strengthening of the labour market and economic activity has been growing at moderate but solid rates. Job gains have grown strong in recent months, and the unemployment rate has remained at low levels. Recent data shows that the growth rate of household spending and business fixed investment has grown in 2018 at moderate rates after a large growth at the end of 2017.
On a twelve-month basis, overall inflation and inflation for items other than food and energy has remained below 2%. The economic outlook has improved in recent months due to the good results evidenced throughout 2017, and since the tax reform approved at the end of the same year.
The committee expected that with gradual adjustments in the monetary policy stance, the economy would continue to behave positively in the medium term and labour market conditions would remain robust. Regarding inflation and its annual base, the committee expected that in the short term this indicator would be close to 2% and that the bank’s goal would be met.
Due to the behaviour of the labour market, the main sectors of the economy and inflation, the committee decided to raise the target range of federal funds from 1.5% to 1.75%. The committee was explicit in that the monetary policy stance would remain accommodative as long as it was necessary for inflation to return to 2%.
This decision was in line with market expectations, so there was no strong reaction from the market. In the projections of the path of the interest rate, there is still no unanimity on what the next steps of the Federal Reserve will be as some expect a stronger policy, so they expect four increases during 2018. For other analysts, the path will continue the road stipulated so they expect only three increases during the current year.
The following graph shows the main projections of the committee. This graph shows economic growth above the natural long-term rate and the rates expected since the December meeting has improved. The unemployment rate also shows a very positive behaviour and is below the long-term rate. Regarding the different inflation measures, inflation is expected below the bank’s target for 2018, but very close to the target level, and for the next two years, an optimal inflation rate is expected according to the bank’s mandate.
Graph 82.Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, March 2018. Retrieved 23rd March 2018 from https://www.federalreserve.gov/monetarypolicy/files/monetary20180321a1.pdf
In the press conference, the president of the Federal Reserve Jerome Powell expressed that the decision to raise the target range of the interest rate marks another step in the normalisation of monetary policy, a process that has been underway for several years. But in his statements, some caution was evident and showing that the path of the interest rate considered only two more hikes in 2018.
Job gains averaged 240,000 per month in the last three months, which is a very positive rate and makes it possible for new workers to be absorbed. The unemployment rate remained at low rates in February, standing at 4.1%, while the rate of labour market participation increased.
According to Powell, that is a positive signal given that the economically active population is getting older, so this leads to the participation rate to the downside, but with the new entries this negative effect is offset by the entry of new workers.
Also, the president of the Federal Reserve has concluded that there are certain specific factors that have contributed to the greater economic growth observed in recent months and these are:
- Tax reform
- Ongoing Jobs Gains
- Foreign growth is strong
- Overall financial conditions remain accommodative
Regarding inflation, Powell was clear that inflation was still below 2% regardless of what measure was used. According to the president of the Federal Reserve, this was due to unusual price reductions that occurred in late 2016 and early 2017. But for Powell, as the months passed in 2018, these unusual events would disappear, and inflation would be very close to 2 %.
In his statements, the president of the Federal Reserve specified that, if the rates rose too slowly, this would increase the risk that monetary policy would have to adjust abruptly in the future if a shock should occur in the economy. At the same time, the committee wanted to prevent inflation from remaining below the target which could reduce the chances of acting quickly in the face of a recession in the US economy.
Finally, Powell pointed out that the reduction in the balance sheet that began in October was progressing smoothly. Only specific conditions of the economy could curb the normalisation of the balance sheet of the Federal Reserve. President Powell was emphatic that they would use the balance sheet in addition to the interest rate to intervene in the economy if a deep economic recession were to occur.
In conclusion, the federal committee decided to raise the federal funds rate as expected by the market due to the good performance of the economy which continued to grow at high rates and above the long-term level. Although inflation was not at the desired level, according to the committee, this was due to transitory effects that would fade over the months, and thus inflation would be in the target range.
As already mentioned, the economy showed good signs due to the labour market, so the bank decided to raise rates, but the committee remained cautious about the future of the economy because it was not ruled out that a recession would occur. According to the statements made at the press conference, some indecision was evident on the part of the committee as they evaluated the two possible scenarios against the interest rate.
If they raised it too quickly they could slow down the economy and thereby affect the labour market, which would lead to a drop in inflation, which would lead to a complex economic scenario as future increases would not be possible, and this would restrict the use of the monetary policy. On the contrary, If the committee raised it too slowly, a scenario could be generated where any economic shock, whether internal or external, could also affect the economic growth of the United States and limit future increases in the interest rate.
The market is still undecided if the FED will make two or three more rate hikes during the current year. Some analysts question why the Federal Reserve continues to raise rates if the inflation rate still shows no stability. For them, the central bank should be more cautious in its monetary policy because they could be in the second scenario where the economy still needs an accommodative policy so that the medium term could be limited future increases in the rate as well as the normalisation of the balance sheet.