As another FOMC meeting comes and goes, the financial market’s eyes have remained on the Fed as many speculate that the world’s most influential central bank will cease with its rate increases. Target ranges for the federal funds rate have skyrocketed from the zero bound in March of last year to 5 to 5.25 % just 14 months later, yet markets predict that the FOMC’s next meeting on June 14 will mark the end of the short-term rate’s upward slope, with the CME FedWatch tool estimating an 84.5 % chance that the federal funds rate will remain at the target range it was set at last week. Indeed, after the May 3rd meeting Fed Chair Jay Powell threw a bone to such predictions, mentioning that, “People did talk about pausing, but not so much at this meeting… We feel like we’re getting closer or maybe even there.”
Monthly CPI between April 2022 and April 2023
Source: U.S. Bureau of labor Statistics
On the one hand, the popular demand for a pause in interest rate hikes seems more than plausible. The April Consumer Price Index report found a 0.4% increase in the index last month, culminating in an annual inflation rate of 4.9% that is the lowest found since April of 2021. In total, inflation’s annual trajectory has declined every month since June of last year, with continued monthly declines in grocery and gas prices above all assisting the CPI to its new low. Meanwhile, renewed banking stress with the failure of First Republic Bank and cracks in other regional banks as well as the “significant risk,” according to the Congressional Budget Office, of a federal government debt default come June 1 may be enough to compel the Fed to further tighten credit conditions. From declining inflation to banking turbulence to debt ceiling crisis, the growing wave of recessionary panic may be enough to topple over any lingering arguments for furthering interest rate tightening, but even within the FOMC, a vocal minority is making the case for continuing the Fed’s monetary contractions.
Michelle Bowman on the Fed’s Board of Governors, for example, contends that, “Should inflation remain high and the labor market remain tight, additional monetary policy tightening will likely be appropriate to attain a sufficiently restrictive stance of monetary policy to lower inflation over time.” Indeed, while more ambiguous factors in financial markets may recommend a pause in rate hikes, movement in concrete indicators of economic activity such as consumer spending and wage growth suggests that inflation is still all-too problematic. Unemployment in April fell to 3.4% while average hourly earnings still rose at a consistent 4.4%, signs of labor market defiance to the Fed’s tightening. In fact, such economic resilience may be the result of expectations that the Fed pauses its tightening in the first place, as economic activity in the present is always guided by future expected cash flows. Insofar as that’s the case, the Fed may be able to convince producers and consumers alike to expect a lower inflation rate if it were to defy current expectations and continue hiking rates. Given the fact that the actual inflation rate is the expected inflation rate, since firms increase their costs and consumers increase their spending based on what they think inflation will be, it may be the psychology behind another rate increase that could lure the FOMC toward such a decision.
Overall, the debate on whether or not the Fed should halt or increase interest rates relatively mirrors the more academic debate of discretion versus rules in monetary policy. Whereas those who advocate for a “discretionary” monetary policy believe that the Fed should take into account any number of factors it deems necessary, including debt crisis and banking instability, advocates for a “rules-based” monetary policy argue that for the sake of human error and ignorance, policymakers should narrow in on key data including labor market activity and consumer spending, which show well-above target inflation. While the two sides clash in the present, not even the coming months may be able to crown a victor; in the world of economics, not even hindsight is always 20/20.