Surprising Many, Federal Reserve Declines To Raise Interest Rates

After months of hinting that interest rates would be rising this month, signs of economic weakness led the Federal Reserve to hold back.

Economy Heartbeat

After weeks of speculation about what it might do, and months in which it signaled that a rise in interest rates was inevitable at some point, the Federal Reserve announced today that it would be leaving interest rates unchanged for the time being:

WASHINGTON — The Federal Reserve announced on Thursday that it would keep interest rates near zero as officials assessed the impact of tighter financial conditions and slower global growth on the domestic economy.

The Fed’s decision, widely expected by investors, showed that officials still lacked confidence in the strength of the domestic economy even as the central bank has entered its eighth year of overwhelming efforts to stimulate growth.

“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” the Fed said in a statement after a two-day meeting of its policy-making committee, the Federal Open Market Committee.

The Fed still plans to raise rates this year, according to new economic projections it also published on Thursday. Thirteen of the 17 members of the committee predicted that the Fed would raise rates at least 0.25 percentage point, and six predicted an even larger increase.

The policy-making committee has scheduled meetings in October and December, and an initial move is possible at either meeting.

Janet L. Yellen, the Fed’s chairwoman, said at a news conference after the release of the statement that the decision to keep rates near zero had been a close call.

“The recovery from the Great Recession has advanced sufficiently far and domestic spending has been sufficiently robust that an argument can be made for a rise in interest rates at this time,” Ms. Yellen said. But she said “heightened uncertainness abroad” and slow inflation had convinced the committee to wait for more evidence, including continued job growth, “to bolster its confidence.”

Ms. Yellen said China’s economic troubles, and slower growth in other foreign economies, “bears close watching” and was a crucial reason the Fed chose to delay raising interest rates. But she said the Fed’s concern should not be overstated. So far, she said, foreign developments had not altered significantly the Fed’s expectations for domestic economic growth.

One official, Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, voted to raise rates at the September meeting, the first such dissent at a meeting this year.

Fed officials are convinced labor market conditions have nearly returned to normal. In the new round of economic projections, officials estimated that the unemployment rate would stop falling when it reached 4.8 percent, just slightly below the August level of 5.1 percent.

“The labor market continues to improve, with solid job gains and declining unemployment,” the statement said.

But the share of Americans with jobs remains well below the level before the recession, and the Fed’s projections imply that some of that decline is probably permanent.

Officials also remain confident that inflation will rebound, although perhaps a little more slowly.

Even so, Fed officials predicted that the Fed’s benchmark rate would rise gradually, reaching 2.6 percent by the end of 2017. In June, they predicted that the rate would reach 2.9 percent by then.

Officials also expect the rate to reach a new plateau of about 3.5 percent, less than the June prediction of 3.8 percent and significantly below the level the Fed once regarded as normal. If rates remain at that level, it would limit the Fed’s ability to respond to economic downturns.

For much of the summer, Fed officials appeared ready to start raising the central bank’s benchmark interest rate at this meeting in September. The unemployment rate fell to 5.1 percent in August, and officials predicted continued job growth and a gradual rebound in inflation.

For the better part of the summer, the Federal Reserve had been hinting that rates were likely to rise in September, albeit likely by a very small amount. Given the fact that rates have been effectively zero when adjusted for inflation since the Great Recession some seven years ago, it was inevitable that we would come to the day that interest rates would be allowed to rise again. For one thing, the rates we’re at right now are artificially low and were put there largely in response to the liquidity crisis that developed in the wake of the collapse of the housing market and the financial crisis that resulted from that. While that has benefited many Americans in the form of lower interest rates for mortgages and car loans, it has also harmed those who rely on interest and dividends for some or part of their income while also encouraging a large amount of investment to go into the stock market due to the fact that it was one of the only places offering a decent rate of return without insane levels of risk. Additionally, the fact that interest rates are so low means that the Federal Reserve has few options available to it to stimulate the economy in the event of an economic downturn. Finally, while inflation remains essentially non-existent there is still the possibility that an overheated economy could lead to a price spiral in the future. Raising interest rates even incrementally would theoretically allow the economy to continue growing at a normal pace without risking the kind of overheating that would lead to an inflationary spiral.

Notwithstanding all of those arguments, though, and notwithstanding the fact that everyone in Wall Street and the financial sector knows that interest rates are going to rise at some point, there were plenty of signs over the summer that this might not be the right time to start taking steps that could slow the economy down. In China, for example, a falling stock market began to have a worldwide impact that lasted into August, and signs began to appear that suggested that one of the world’s fastest growing economies could be slowing down significantly. Closer to home, the American economy, which had actually shrunk slightly in the first quarter of the year, rebounded slightly in the second quarter but still showed signs of weakness. At the same time, the job market seemed to be losing the momentum it had earlier in the year, which some analysts suggested could be tied to the domestic impact of the downturn in China. Given all of that, many analysts suggested that the Fed should hold off on raising interest rates until more data is available about the state of the domestic economy. Raising interest rates while the economy is weakening, they argued, could have slow the economy down ever more and cause problems heading into the Christmas season, which is make-or-break for many industries. With its decision today, it would appear that the Federal Reserve agreed with those arguments.

While the Fed’s decision was not surprising in light of the recent economic data, some were surprised by how hesitant the board seems to have become:

The Federal Reserve appears hesitant about raising interest rates, experts said in the wake of Thursday’s announcement, despite months of anticipation and widely differing forecasts at Wall Street’s biggest firms.

Although a majority of economists on Wall Street thought the Fed might not make its move on Thursday, several said the language in the rate-setting committee’s statement suggested that policy makers were even more reluctant to tighten monetary policy than they had thought.

“It felt like a dovish result with a dovish statement,” said Carl R. Tannenbaum, chief economist at Northern Trust in Chicago. “Before this meeting, there was a supposition that they’d set the table for a future move. I didn’t see any silverware in this announcement, and I think October is off the table.”

“I don’t think they are in much of a hurry,” he added. “The international situation must have generated a real re-evaluation.”

But others suggested that the Fed was prepared to act quickly once policy makers came to believe that global conditions had stabilized. And that could come before the end of the year.

“The global deterioration has caught their attention and clearly, that was the main factor,” said Michael Hanson, senior United States economist at Bank of America Merrill Lynch. “I don’t think this will keep them on hold for an extended period of time. Both the meetings in October and December remain live.”

Several experts said they were struck by the second paragraph in the Fed’s statement, in particular the conclusion that global volatility and economic events “are likely to put further downward pressure on inflation in the near term.”

Ian Shepherdson, chief economist at Pantheon Macroeconomics, said those conclusions constituted the major news in Thursday’s announcement.

“I’m not surprised they didn’t move, but I am slightly surprised that they were so explicit with their reasoning,” he said. “The new stuff is the recent financial global developments, and for now they are kind of paralyzed.”

Mr. Shepherdson said he expected the domestic economy to continue to strengthen in the months ahead while volatility lessens in China and other markets, prompting a tightening in December.

Based on how the board worded its communication today, it would take some evidence of strong economic growth, along with real signs that the instability overseas had passed, for them to raise interest rates before the end of the year. I suppose it’s possible that things could pan out that way, but based on how the summer has gone, that seems unlikely. Instead, we’re likely to see more evidence that while the economy is growing it is doing so at a pace so slow that raising rates at this point would be a mistake. Additionally, the fact that there is still no real sign of inflation on the horizon suggests that there’s no need for rates to start rising any time soon. If the Fed is wise, it will sit back for a while longer before fighting a war against inflation that doesn’t even seem to be happening at the moment.

FILED UNDER: Economics and Business, US Politics,
Doug Mataconis
About Doug Mataconis
Doug holds a B.A. in Political Science from Rutgers University and J.D. from George Mason University School of Law. He joined the staff of OTB in May 2010. Before joining OTB, he wrote at Below The BeltwayThe Liberty Papers, and United Liberty Follow Doug on Twitter | Facebook

Comments

  1. al-Ameda says:

    Exactly the right decision.

    There is low steady economic growth, very low rates of inflation, and energy prices are falling. Also, there is too much unrest in the domestic equities market, as well as in overseas markets.

  2. C. Clavin says:

    But, but, but, but….conservatives Republicans have been warning about runaway inflation for years.
    It’s all that idiot Paul Ryan ever talks about.
    Are you saying they have been…WRONG!!!…the entire time.
    Dead wrong.
    Tragically wrong.
    But haven’t Republicans been basing policy on their wrong-headed delusions?
    Stephen Moore…chief economist with the Heritage Foundation, a Tea Party lobbying group…said our debt was going to spike inflation and the price of gold would go to $2,000. Stephen Moore is being now wooed by almost every Republican candidate for President.
    Can we finally admit that Republicans know about as much about economics as they do foreign policy and science?

  3. gVOR08 says:

    The arguments for raising rates seem to come down to – we have no inflation now, but we might sometime; and – we need room to lower rates if it turns out we screwed up by raising them. Has anyone offered a cogent argument for raising rates? I’ve yet to hear one.

  4. Dave Schuler says:

    I agree it’s the right decision. However, the decision has implications. Persistent low interest rates have serious implications for significant sectors of the economy, e.g. pension funds, insurance companies, and something needs to be done to minimize downside risk. The Congress really needs to take some steps. The Fed can’t be the only institution that does all the heavy lifting.

  5. Jc says:

    Yes, to test the economy. All this over 25 basis points. Oooooooh scary hike coming…I think the economy is in good enough shape to handle going from ZIRP to 25bp. I am sure the Fed knows what it is doing but really? We are so paranoid

  6. gVOR08 says:

    @C. Clavin:

    …Republicans know about as much about economics as they do foreign policy and science

    Rich people know, or at least know they’ve always been told, that high interest rates are good for rich people and low rates are good for everybody else. All they feel a need to know before deciding they want higher rates.

  7. DrDaveT says:

    @gVOR08:

    Rich people know […] that high interest rates are good for rich people and low rates are good for everybody else

    Not if they’re really low.

    At the moment, there are no low-risk investments that are any better than putting your money in the mattress. In particular, the safest investment out there that is even keeping pace with inflation is… the stock market. So how, exactly, are the less-wealthy supposed to save? All of those retirement calculators that assume you can always get a 4% risk-free return on savings are not helping at the moment.

  8. Tony W says:

    @gVOR08: The only thing I’ve heard is that it would be done to slow down a booming economy – making things sustainable over the long term. From what I see and hear, we’re in little danger of that problem – although my stock market investments continue to do well. I really feel like this is more art than science.

  9. Tyrell says:

    My view is that raising interest rates is detrimental to the home construction and real estate industry. I remember full well the economic situation of the seventies. The people got hit with a triple whammy: high interest rates (10% + mortgage rates, high inflation, and high unemployment). President Nixon tried wage and price controls, but that seemed to backfire. Someone was rigging the economy, setting the tables, and stacking the deck.
    No, the high mortgage, high down payment days of the ’70’s still bring bad memories ! And, of course, the “gas shortage” hoax that occurred then.

  10. michael reynolds says:

    Let us take a moment to note that we are worried about the Chinese economy, the European economy, the Japanese economy, even the Russian economy.

    And which world-class economy is doing best? Why, that would be Barack Obama’s America. You remember him, the incompetent boob in over his head?

  11. munch the blast says:

    @asshat

    please refer to these charts for the state of the economy

  12. CrustyDem says:

    @DrDaveT:

    Come on, safe investments should always be compared relative to the rate of inflation. Back when you could get 5% interest from your bank, inflation was 8-12%; today you get 0% and inflation is ~1%. There was a sweet spot for CDs from 1984-1991 where you could easily beat inflation, but since then? Not so much.

    There is no reason whatsoever to raise interest rates. Inflation for 2015 is 0.0% Wages are not rising fast. I’m sympathetic with the idea that a small increase would be ideal, but not standard economic model would suggest that the usual risks for low interest rates are currently a concern.

  13. michael reynolds says:

    @munch the blast:

    You don’t quite get the concept of ‘relative’ do you? You know, like, I’m tall but not NBA tall? Or, you’re poor compared to Bill Gates? Our economy isn’t the best ever, it just happens to be better than every other comparable economy.

    If you want to argue that point, go right ahead. But don’t come here and call people names when you lack the wit to understand the point.

  14. al-Ameda says:

    @munch the blast:

    @asshat

    Did your mom help you with the “@” or with the “asshat” or both?
    Stay classy.

  15. Stonetools says:

    I called it a while ago. Frankly, there was no good argument whatsoever for an interest rate rise and plenty of arguments against it. Once Yellin said, as she did earlier, that the decision would be “data driven”, the prediction should have been easy-there was no data on which to base an argument for a raise. ( I would like to hear Lacker’s argument for a decision to raise-it probably comes straight out of 1979).
    Given the current U.S. and world economy, I don’t think there is any good reason for a rise before spring 2016 at the earliest. There are long term disinflationary pressures on the world economy that won’t be going away for a while.

  16. turgid jacobian says:

    @munch the blast: gee i sure wonder why all those charts start in different years…

  17. gVOR08 says:

    @DrDaveT:

    So how, exactly, are the less-wealthy supposed to save?

    By saving. I don’t mean to sound flippant, but low interest rates reduce incentives to save, they don’t prevent saving. Individuals still need to save, and interest rates will come up at some point.
    I’d like to make more on my money just like everyone else, but my desire for free money is not a cogent economic argument for higher rates. I should also point out that the Fed doesn’t give a spit about what Dr. and Mrs. retired dentist want, they care deeply about what banks want.

  18. gVOR08 says:

    @Tyrell: You know, if you strip out the conspiracy theory nonsense, that’s actually a fairly good comment. Many of our current leaders started their careers in the 70s and early 80s. Inflation was their foundational experience. And many of them appear to have learned little in the intervening 40 years.

  19. DrDaveT says:

    @CrustyDem:

    Come on, safe investments should always be compared relative to the rate of inflation.

    I think that’s exactly what I said, and did.

    Back when you could get 5% interest from your bank, inflation was 8-12%

    Y’know, you could have easily checked that online before posting. It turns out that it is not merely false, it’s exactly backwards. From 1983 to 2008, the annual average of 5-year CD rates was always over 5%, while the CPI only broke 5% once. In 1985, inflation was under 4% but CDs were paying more than 10%. In 1999, inflation was 2.2% and CDs were paying 6%.

    For the last few years, on the other hand, inflation has been ~2% while 5-year CDs pay 1%.

    @gVOR08:

    I don’t mean to sound flippant, but low interest rates reduce incentives to save, they don’t prevent saving.

    Sure — but low interest rates don’t just reduce incentives, they make it harder to save. At present, for every dollar you’re going to need in retirement you need to set aside more than a dollar today. That’s a huge difference from the last 5 decades, when you could get a real dollar in retirement by setting aside 50 cents in your prime.

  20. grumpy realist says:

    I certainly wish the WSJ should figure out whether it wants high interest rates or low interest rates. The same issue that bemoans the cost of borrowing money for corporations then turns around and harangues Yellen because of all their Baby Boomer readers with their retirement portfolios now all in bonds which are returning 1% a year sob sob oh those poor, put-upon retirees…

    It’s as if the WSJ were written by a bunch of lazy portfolio analysts furious that the “life-cycle portfolio strategies” they were taught back in 1980 GASP don’t work any more and they’ll have to learn new tricks before charging their yearly 3% fee.

    Feh.

    (Oh, and of course it’s all Obama’s fault. Naturally.)

  21. Guarneri says:

    To read the thread you would think inflation is the only determinant of interest rates. Wrong. That’s why there is a term structure, and why rates for govt is one number for each tenor or locale, various corporates another, pay day loans another……..

    Rates, that is, the real rate could be let find currently equilibrium conditions. The low rate gambit to reignite the housing market is obvious – construction is labor intensive – for subprime financed auto equally obvious – a union payoff – for govt equally obvious – it helps govt debt service, all while hosing savers, trying to turn them into goods buyers. FUBAR

    Any look at the composition of household consumer outlays by order of size would not, by the way, indicate zero inflation. Rents are up; housing prices as well. Food?? Really? Medical care? Up, up and away. College students and the parents thereof might beg to differ as well. They play games with imputed quality improvements to reduce apparent price. The only things that seem to be tamping down prices are imported goods like clothing and electronics, which I know you folks all adore. And the fall in energy costs or other commodities is an indicator of a slack economy.

    I’m not seeing a rosy picture here.

  22. C. Clavin says:

    @Guarneri:

    I’m not seeing a rosy picture here.

    Of course not…you and Paul Ryan and Stephen Moore and Larry Kudlow and Art Laffer and the rest of the right-wing nut-job know-nothings have been preaching gloom and doom forever.
    Don’t you ever stop and think to yourself…fwck…I’m always wrong; what’s up with that?

  23. Just 'nutha ig'rant cracker says:

    @DrDaveT:

    So how, exactly, are the less-wealthy supposed to save?

    No, you have that wrong. The less wealthy aren’t supposed to save. They and their poverty exist so that they can be criticized for their indolence and lack of saving and planning for the future.

  24. Just 'nutha ig'rant cracker says:

    @munch the blast: Who is “lutfur” and why is it that when I visited his site, I didn’t see any blogs posted?

  25. michael reynolds says:

    @Guarneri is the same economic savant who predicted the utter failure of what he was then pleased to call, Government Motors. And yet, I could swear I saw a brand-new Buick the other day.

    He’s an Ayn Rand guy. You know, like Bowe Bergdahl.