Cogito Ergo Non Serviam
Fed Holds Rates Steady on Stagflation Worries
The Federal Reserve had its Open Market Committee meeting yesterday, and it announced that US interest rates will stay right where they are for now. On the one hand, there is a genuine weakening in the labor market. This suggests lower rates are in order to maintain employment levels. On the other hand, inflation is ticking back up. That calls for higher rates to slow down price increases. Given the tension between the two policy goals, the Fed decided to let events take their course. Kicking the can down the road is occasionally the right thing to do, as it is here.
"The labor market is solid, inflation is low. We can afford to be patient as things unfold," he said following the announcement. "There's no real cost to our waiting at this point."
"There's a great deal of uncertainty about . . . where tariff policies are going to settle out and also, when they do settle out, what will be the implications for the economy, for growth and for employment," the Fed chief added.
Compare that to the Bakn of England, which cut rates this week. The BBC reported
The Bank's governor Andrew Bailey begins his news conference by saying cutting rates was in part due to inflation being lower than expected in March.
However, he goes on to say inflation is expected to rise temporarily, largely due to higher energy prices.
He says the message the Bank is getting from businesses is one of "caution" when it comes to investing.
In other words, inflation in the UK and unemployment are at levels and are moving in the right directions for a clear-cut policy decision.
The fact of the matter is that the Fed policy was completely transparent before the tariff announcements. Slowing inflation and the under-performing labor market combined to make cuts to the Fed Funds rate the correct macro-economic medicine.
The tariffs are a sudden tax increase, which could be a good thing if the economy were over-heating. That is not where the American economy is. Instead, the tariffs are the equivalent of pulling the emergency brake on a train. Things shudder to a violent stop.
A similar event occurred in the 1970s, when OPEC embargoed oil exports. Oil is so fundamental to the economy, and was more so 50 years ago, that is was effectively an across-the-board tax. Paul Volcker, the chairman of the Fed back then, raised rates to about 15%.
The Federal Reserve states the following
Over the course of 1980, interest rates spiked, fell briefly, and then spiked again. Lending activity fell, unemployment rose, and the economy entered a brief recession between January and July. Inflation fell but was still high even as the economy recovered in the second half of 1980.
But the Volcker Fed continued to press the fight against high inflation with a combination of higher interest rates and even slower reserve growth. The economy entered recession again in July 1981, and this proved to be more severe and protracted, lasting until November 1982.
History does not repeat itself, as Mark Twain observed, it does rhyme. The Fed will have to raise rates if these tariffs persist for very long, as the inflation rate will be felt by more people than unemployment. Central banks never admit this, but despite a dual mandate on jobs and inflation, inflation comes first.
Rates will rise, but not just yet.
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