Time to Raise Rates?

James Bullard, President of the St. Louis Fed, thinks that the Fed should raise rates.  He cites the low jobless rate, inflation near target, ex-oil, and the need to move early, rather than be late.  I think he is alarmist, but I can see the argument for raising rates in order to establish a sense of normalcy, to draw a line under the crisis, if you will.

US inflation is very low, having been driven down by the oil price.


Core inflation is higher, but still well below the Fed’s 2% target. And, by the way, the target is the Personal Consumption Expenditure (PCE) deflator, not the CPI.  Both are in the charts for illustration, but the PCE deflator is the main event.


Inflation expectations are pretty well anchored. The U of Michigan 1 year ahead survey expectations (gray) have been relatively steady for years, the very definition of “anchored”. They are a bit high at 3%, but they have been high relative to actual inflation for years. They are biased, but they are steady and that is the important point.


Market based expectations have been more volatile, but lower, averaging just 1.1% for the last 5 years. Bullard is more bullish on inflation than the markets.

What about jobs?  Job creation has been very good recently.  February saw 295K jobs created while it made us shiver. The 6 month average is now 293K and has been over 200K for about 2 years. That is great, but look at the red arrow. It points to the 34,000 monthly average number of jobs created since the beginning of the credit crisis in June 2007.

US NFP 031315

Add those up and you get roughly 3.2 million jobs created since mid-2007. That is far fewer than what has been needed to make up for job losses and to accommodate the roughly 1% per year increase in the labor force that is typical in the US.  Add in the massive increase of capacity in China, among others, and their desire to keep their people employed and you probably are going to have little upward pressure on labor costs in the US.

That is not to say that we should be sitting with a negative policy rate while the economy is expanding as it is.  The need for a high Fed funds rate versus inflation is behind us.  That was the fight of the 70s and 80s and it probably needed to be reinforced in the 90s to break the inflation psychology for good. That fight is done.

US CPI- FedF 031315

Fed Funds minus Core PCE Deflator

My guess is that current circumstances will require no more than a real (inflation adjusted) funds rate of 1% on average through the cycle versus the 2% rule of thumb used in the Taylor rule.  As an interim target, during this modest expansion, I would say that the Fed should aim for a rate equal to inflation.

As I said above, it probably makes sense to start raising rates soon, but accompanied by language indicating a return to normalcy, not the alarmism of President Bullard.

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