Is the Fed Playing Politics With Interest Rates?

When the U.S. Federal Reserve decides where to set interest rates, it’s supposed to set aside political considerations and focus solely on what’s best for the economy. I’m starting to wonder, though, whether the Fed is starting to stray from this model of independence — and I’m worried about what that might mean for inflation.

At their most recent policy-making meeting, Fed officials decided to keep short-term interest rates near zero, and gave no indication that they’re planning to raise rates significantly (or at all) over the next six to 12 months. This commitment to easy money must be seen as somewhat surprising, given that inflation is running well above the central bank’s long-term target of 2%. As of September, the price index for personal consumption expenditures was up 4.4% from a year earlier, the fastest rate of growth in 30 years. Even if one removes volatile food and energy prices, the PCE inflation rate exceeds 3.5%, still the highest in 30 years. These data suggest at least a nontrivial risk of a return to the persistent inflationary psychology that the U.S. experienced during the 1970s, and that required a brutal period of extremely tight monetary policy to tame.