Fed likely to keep interest rates low
WASHINGTON — The Federal Reserve is expected to send a clear message when its latest policy meeting ends Wednesday: Interest rates will likely stay ultra-low for the foreseeable future.
Behind that message is a view that has gained support at the Fed as the U.S. economic expansion has entered a record 11th year: That contrary to long-standing thinking, a robust job market won’t necessarily fuel high inflation. This view has freed the Fed’s policymakers to keep their benchmark short-term interest rate low.
The unemployment rate is just 3.5 percent, the lowest in 50 years. And yet inflation is still below the Fed’s 2 percent target level.
The Fed has cut its benchmark short-term rate three times this year to a range of just 1.5 percent to 1.75 percent. Chairman Jerome Powell has described those cuts as “insurance” intended to offset the drags from the prolonged U.S.-China trade war and a global economic slowdown.
But economic data also suggest that the cuts reflect the Fed’s evolving views. The economy increasingly appears unable to handle higher rates. The Fed tightened credit four times last year. And its final rate hike, coupled with a projection that two more increases were coming this year, sent stock markets plunging. The market’s fear also reflected concerns that the Fed was selling off too much of its Treasury portfolio, which can send interest rates up.
Persistently low inflation and steady if sluggish economic growth have led many Fed officials to rethink their view of the so-called “neutral rate.” This is the point at which the Fed’s key rate is believed to neither accelerate economic growth nor restrain it. The neutral rate typically shouldn’t change very often or very much. But the Fed’s policymakers estimate that the neutral rate is now 2.5 percent, down from 3 percent as recently as September 2018.
And Fed Vice Chair Richard Clarida suggested last month that full employment — the lowest rate that the Fed thinks the jobless rate can go before it starts escalating inflation — could be as low as 3.6 percent. A year ago, the Fed thought it was 4.4 percent.
Powell acknowledged in a speech last month that the declines in such estimates were among the justifications for this year’s three rate cuts.
“They provided another reason why a somewhat lower setting of our policy interest rate might be appropriate,” he said.
That means that those rate reductions weren’t just about responding to temporary economic weakness as a result of Trump’s trade conflicts. They were also about setting rates at a more sustainable level. Even if the economy were to improve — as last week’s robust jobs report for November suggests it may — the Fed seems unlikely to reverse this year’s rate cuts anytime soon.
In fact, economists expect the Fed on Wednesday may again lower its estimates of full employment and the neutral rate to better reflect how low unemployment and inflation have remained.
