U.S. Economy

The Fed Is About to Make a Mistake

The central bank should lower rates, but that won't happen at next week's policy-making meeting.

Your move.

Photographer: Andrew Harrer/Bloomberg

Next week, officials at the U.S. Federal Reserve will hold a crucial meeting on whether to raise interest rates. Whatever they do, it will probably be a mistake.

More than seven years after the recovery began in mid-2009, inflation remains below the central bank's 2-percent target, indicating that the economy is still operating below potential. As of July, consumer prices were up just 0.8 percent from a year earlier. Excluding volatile food and energy goods and services, they were up 1.6 percent.

Worse, markets appear to be losing confidence that the Fed will ever reach its target: Yields on Treasury bonds suggest that traders expect inflation to average less than 2 percent five to 10 years from now. As the experience of the Bank of Japan indicates, restoring such confidence is not easy.

The Fed is also falling short of its goal of "maximum" employment. Although the unemployment rate has returned to its 2007 level of 5 percent, the fraction of Americans in their prime working years who have a job remains well below its pre-recession level. 

All this argues for the Federal Open Market Committee, the central bank's policy-making arm, to provide added stimulus by cutting interest rates a quarter percentage point at its Sept. 21 meeting. This is all the more important because the Fed's capacity to respond to further shocks is limited, given its reluctance to take interest rates below zero and the large amount of bond-buying that it has already done. It should thus do all it can to ensure that the economy is healthy enough to weather whatever may come.

Unfortunately, I'm confident that the Fed won’t cut rates. Doing so now might require officials to raise rates more rapidly in the future -- an outcome that they are, for reasons that are unclear to me, determined to avoid.

So the central bank will either raise rates by a quarter percentage point or do nothing. The latter appears more likely, given that two Fed governors have spoken out in favor of caution. The last time the Fed took an action from which two governors dissented was in 1993. 1  In either case, it will be the wrong move.


This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

  1. See the great data on FOMC dissents being maintained by the Federal Reserve Bank of St. Louis.

To contact the author of this story:
Narayana Kocherlakota at nkocherlako1@bloomberg.net

To contact the editor responsible for this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net

Before it's here, it's on the Bloomberg Terminal.