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Fed Cornered on Monetary Policy?

November 12, 2018

Federal Reserve Chairman Jerome Powell is in a tough situation. Americans expect him to pull the right levers, so the economy remains strong and inflation doesn’t run rampant.

 

That isn’t the tough part though. Every Fed chair is held to that standard.

 

For Powell, It’s the environment in which he has to work that makes his situation difficult. Under the circumstances, there isn’t much he can do to make things better. However, there’s a whole lot he could do to make things worse.

 

Consider that U.S. Gross Domestic Product (GDP) growth was 4.2 percent in the second quarter, and it’s above 3 percent overall for 2018 so far. That’s the best in years.

 

Unemployment is the lowest it’s been in 50 years. And inflation, as measured by the Consumer Price Index, is at 2.3 (just above the 2.0 target), though oil prices have driven that up, and they could fall soon.

 

All things considered, these are the results the Fed wanted.

 

But there’s also a desire among the monetary policy makers to raise interest rates, so they have wiggle room to go down during another recession.

 

The problem is, raising rates could cause a recession.

 

A quarter-point rate hike is scheduled for December 2018, and then another three hikes are planned in 2019, which would bring the federal funds rate to 3 percent. That’s the highest level since 2007.

 

And who’s to say there couldn’t be more jumps in 2020? If so, the federal funds rate could be at 4 percent. And if inflation is around 2-2.5 percent, that rate could be too much.

 

The December rise is prudent. Beyond that, things should be monitored monthly and fewer hikes should be considered, unless inflation starts to jump. Look out if that happens.

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