US Federal Reserve rates

  • June 14th: the US Federal Reserve lifted interest rates by a quarter of a percentage point to a range of 1-1.25%
  • Excluding food and energy, prices are only 1.5% higher than a year ago; the FEd’s inflation target is 2%
  • Motivating factor: Chair of the Federal Reserve, Janet Yellen, thinks unemployment is below the natural rate so inflation should soon rise
  • Phillips curve denouncement: After the financial crisis unemployment soared to 10%, which should have seen inflation fall- yet in October 2009, when unemployment peaked, underlying inflation was 1.3% (just below today’s CPI)
  • Could be partially explained by a genuine increase in the NAIRU- the rise in joblessness was permanent – but this is countered by how with unemployment at 4.3% in the USA inflation still remains low.
  • Yet although the Phillips curve currently is not matching reality, there may be three reasons for this:
    • effects of unemployment on inflation can get lost amid temporary economic gyrations – such as when oil prices fall (late 2014) or when mobile data prices drop (Verizon recently began offering limitless data). At this same time, statisticians have increased the weighting they give to such changes.
    • It is possible that inflation will take off sharply when unemployment gets too low rather than gradually as the economy approaches the threshold – happened during the 1960’s, with unemployment under 4%, inflation rose from 1.4% in November 1965 to 3.2% a year later, and almost 5% by the end of the decade. This occurred partly because President Lyndon Johnson encouraged the Fed not to offset tax cuts with tighter monetary policy. This may be repeated with Trump’s administration goals.
    • Emphasis on inflation expectations as well as unemployment. Inflation expectations have sagged while the labour market has recovered. Self-fulfilling expectations could explain low inflation.

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