Amid Uncertainty, Fed's Hike Expected (Dec. 14)

The year is winding down slowly and it  effectively came to an end today for monetary policy.  For years, the Fed pursued an unprecedented policy of accommodation almost out of necessity while a gridlocked Congress declined to fight the recession with fiscal policy tools.

Now that a full-scale economic recovery (measured by jobs, not wages and benefits) is underway in most of the U.S., the Fed seems ready to lift its accommodative monetary policy — and poised to do so out of necessity, if the new president and Congress pursue a fiscal policy that stimulates an economy at risk of overheating.




The Expected Rate Rise

The Fed decided following its meeting to modestly raise the Federal funds rate, increasing the total rate from a range of 0.25-0.50 to 0.50- 0.75 percent.   This was broadly expected, given the Fed’s strong signaling that a change would occur at this point.  It was only the second time in the last decade that the Fed has raised its rates, following last December’s raise of a quarter percent.

This raise in interest rates reflects many Fed official’s belief that the economy is running at or near its long run capacity for growth and employment. The Fed has taken this as the proper time to begin returning to the federal funds rates neutral nominal rate, the point at which interest rates are not aiding or hindering economic growth.

Evidence of recovery:

  •  GDP growth of 3.2 percent in the last quarter
  • . Price index for personal consumption expenditures up nearly 1.5 percent
  •  4.6 percent unemployment, with stable participation rates over the last two years
  • Core Interest rates rose to 1.75 percent below the target rate of two, but officials also notedinflation had begun to rise

The Fed further announced that it intends to raise the federal funds rate three times in 2017, following its November prediction of two increases next year.  Yellen added that the Fed intends to continue reinvesting proceeds from maturing Treasury Securities and principal payments and intends to continue doing so until the federal funds rate has become more normalized.

Macro Projections

The Fed’s economic projects are slightly more optimistic in this release then they were in September, signaling the Fed’s confidence in the economy and its sustainability going forward.

Along with its announcement, the Fed released a “dot plot,” an important tool in understanding how the Fed views  general economic trends over the next few years.  The dot plot chart indicates where each participant believes the federal funds rate should be at the end of the next few year and in the long run.

This indicator shows how FOMC members feel about economic and monetary conditions going forward.  The median FOMC member predicts a rate between 0.5 and 0.75 percent for the end of this year, gradually rising to 2.9 percent in the long term — a slightly more aggressive prediction than that of the September release and reflects the Fed seeing the economy consistently improving modestly over the next few years.

The Fed has also issued predictions for  economic indicators over the next year:

  •  Expected growth:  2.1 percent next year
  •  Unemployment:  4.5 percent over 2017
  •  Interest rates expected to rise to about 2 percent after 2018, fairly consistent thereafter

Accounting for Trump 

Many analysts wondered if the Fed would set interest rate projections with Trump’s  promises of massive spending and tax cuts in mind.  In fact, the Fed did not strongly alter its predictions from its last announcement, indicating that officials are not bracing for an increased burst of growth or inflation.

Tax cuts and infrastructure spending being championed by Trump would in theory generate stronger growth by increasing the budget deficits. It’s the kind of fiscal support that both Yellen and her Fed predecessor, Ben Bernanke, called for in the past.  But Yellen said today that such policies would be unlikely to maximize employment, since the unemployment rate is now at 4.6 percent, slightly below the Fed’s own long-term target.

Yellen said that while some did take these estimates into account, it was the general consensus of the group that it was too early to predict the effects of potential fiscal policy on the economy at this point.

Yellen also said that the Fed would be prepared to change their predictions if the conditions of the market changed considerably, and if necessary the Fed would change its course. She also commented that the Fed is acting under a “cloud of uncertainty,” indicating that the Fed is not quite sure yet how the varied and vague promises coming from the Trump team will affect the economy

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