The Federal Reserve just can’t leave well enough alone

As was expected, the Federal Reserve raise interest rates today, by 25 basis points:

Finally: Fed raises rates for first time in 2016

by Patrick Gillespie @CNNMoney December 14, 2016: 3:15 PM ET

The Federal Reserve increased its key interest rate by 0.25% on Wednesday. It signified the Fed’s confidence in the improving U.S. economy. Rising rates will affect millions of Americans, including home buyers, savers and investors.

Fed officials raised its target for short-term interest rates by 0.25 percentage points to a range of 0.50% and 0.75%.

It was just the second time in a decade that the Fed has raised rates. The first was in December 2015.

“Economic growth has picked up since the middle of the year,” said Janet Yellen, the Fed’s chair. “We expect the economy will continue to perform well.”

The Fed slashed rates to zero in 2008 in the midst of the financial crisis and kept it there during the Great Recession and beyond.

The rate increase indicate that the U.S. economy no longer needs the Fed’s crutches and consumers and businesses can afford to pay more to borrow. America has added jobs for 74 consecutive months and the country’s unemployment rate has fallen to 4.6%, its lowest level since 2007. The U.S. economy has expanded for seven years, even though the pace of growth has been slow.

FOMC projectionsI have a huge problem with the justifications expressed by the Federal Open Market Committee. Here is the .pdf file of their economic projections. The image to the left is a simplified view of the projections on which the FOMC took its judgements.

First of all, when Dr Yellen said, “We expect the economy will continue to perform well,” a projected 1.9% real growth for the current year — up 0.1% from the September guesstimate — does not strike me as performing well. When Dr Yellen said, “We expect the job conditions will strengthen somewhat further,” it seems difficult to reconcile that with their projections that U-3 will remain at 4.5% throughout the next three years, only 0.1% lower than the last reported U-3 rate of 4.6%.1 About the only thing that the FOMC projected increasing was the federal funds rate, and their projection of higher interest rates did not translate into estimates that the economy would show stronger growth.2

I’ve said it before: The Fed wants to tweak the economy into increased growth, but can’t. The Fed wants to see inflation at around the 2% mark, but can’t achieve that, either. The problem is one that the government and the professional economists never want to admit, that the economy is more than two hundred million economic actors taking over a billion economic decisions every single day. There is no way that twelve members of the FOMC, or the President’s Council of Economic Advisors, or the Congressional Budget Office, or Nobel laureate Paul Krugman can anticipate and guide an economic leviathan like that. But part of the problem is that they think that they can, and they keep trying.

The best thing we could do for the economy is to just leave it alone, stop trying to meddle. That might not help, but at least it won’t hurt the economy.

  1. I have often said that the ‘official’ U-3 rate is bogus, and that it is U-6 which really matters.
  2. The FOMC projected that the federal funds rate would be significantly higher than inflation in 2019, which means that they are projecting that borrowing money will be a dead loss. Entrepreneurs considering borrowing money to start-up or expand businesses will have to forecast high growth rates to justify borrowing money at significantly higher than inflation rates, because they will not only have to see a justification in growth, but also to cover the gap between inflation and interest rates. Of course, businesses don’t get to borrow at the federal funds rate, but at the higher prime rates, set by banks, if their credit is good enough to qualify for the prime rate and not something higher.