The Marriner S Eccles building (Photo by Smith Collection/Gado/Getty Images)
The Federal Reserve will keep raising interest rates, according to minutes from the latest policy committee meeting (January 31-February 1, 2023). They did not state a final interest rate target, but “… all participants continued to anticipate that ongoing increases in the target range for the federal funds rate would be appropriate to achieve the Committee's objectives.”
Decisions about Interest rates and the Federal Reserve’s asset holdings are made by the Federal Open Market Committee, which consists of the seven members of the Federal Reserve Board plus the 12 regional bank presidents. Only four of those presidents have a vote, which they rotate through, but all participate in the discussions.
The Fed increasingly takes what they call a “risk-management perspective.” They acknowledge uncertainty: “Participants observed that the uncertainty associated with their outlooks for economic activity, the labor market, and inflation was high.” More than they have done in the past, the Fed ponders the possibility that they are making a mistake.
They weigh the cost of having interest rates too high relative to the costs of rates being too low: “A number of participants noted the importance of longer-term inflation expectations remaining anchored and remarked that the longer inflation remained elevated, the greater the risk of inflation expectations becoming unanchored. In that adverse scenario, it would be more costly to bring inflation down to achieve the Committee's statutory objectives of maximum employment and price stability.”
That point drives Federal Reserve policy more than any other issue this year. Financial market analysts and public policy commentators look at inflation drivers to estimate optimal policy, and they sometimes wonder why the Fed is not following the seemingly optimal policy. The key issue motivating them is Fed believes that an error leading to persistent inflation is much, much worse than an error leading to recession. That’s because they will, eventually, bring inflation down. But the bringing down of inflation from a temporary rise is much easier than bringing down inflation that everyone expects to continue at a high level. Historical experience in the United States as well as around the world reinforces that conclusion.
Although the FOMC minutes do not indicate just how high interest rates will be pushed, at this meeting “A few participants stated that they favored raising the target range for the federal funds rate 50 basis points at this meeting or that they could have supported raising the target by that amount.”
In a nutshell, we should expect the Fed to continue pushing up interest rates, probably by another full percentage point from the current 4.5%.
