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.
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.