Federal Reserve officials expressed some trepidation as they decided at a mid-December policy meeting to raise short-term interest rates after keeping them near zero for seven years.
Though the decision to raise rates was unanimous, some officials expressed concern about lingering low inflation and the stifling effects on the U.S. economy of a strong U.S. dollar and slow growth overseas.
“Because of their significant concern about still-low readings on actual inflation and the uncertainty and risks present in the inflation outlook, [officials] agreed to indicate that the [Fed] would carefully monitor actual and expected progress toward its inflation goal,” the Fed said in minutes of its Dec. 15-16 policy meeting released Wednesday.
Some officials said they wanted to see confirmation that inflation was actually rising as they looked forward to additional rate increases in 2016, the minutes said. Some also said it was a “close call” as to whether they should move in December.
Inflation has run below the Fed’s 2% goal for 3 1/2 years. The Fed tries to keep inflation near that goal, running neither very high above it or very low below it, to diminish disturbances to the economy. Persistently low readings since the financial crisis suggest underlying weakness in overall economic activity, even though employment has risen and the jobless rate declined.
In theory, inflation should pick up as joblessness falls and slack in the economy diminishes. With that in mind, “nearly all” of the Fed officials in the room at the meeting had become “reasonably confident” inflation would rise in the months ahead, the minutes said. Months earlier, the Fed had set “reasonable” confidence on inflation as a key benchmark for deciding to raise rates.
Still, officials pointed to factors that could throw their inflation outlook off course: Additional declines in oil prices could further weigh on inflation readings, as could continued appreciation of the dollar.
“Although almost all still expected downward pressure on inflation from energy and commodity prices would be transitory, many viewed the persistent weakness in those prices as adding uncertainty or imposing important downside risks to the inflation outlook,” the minutes said.
The Fed said at the meeting and reiterated in its minutes that officials planned to move gradually toward additional interest-rate increases because of these and other uncertainties.
They have tentatively penciled in four rate increases in 2016, according to projections they made public in December. The minutes emphasized their intent to take a go-slow approach.
“A number of participants pointed out that because inflation was still running well below the [Fed’s] objective and the outlook for inflation was subject to considerable uncertainty, it would probably take some time for the data to confirm that inflation was on a trajectory to return to 2 percent over the medium term,” the minutes said. “Gradual adjustments in the federal funds rate would also allow policymakers to assess how the economy was responding to increases in interest rates.”
The outlook wasn’t all worrisome. Officials also pointed to upside risks–notably that consumer spending might take off thanks in part to the benefits to households of lower gasoline prices.
Overall, officials said the risks to the economy were balanced. But staff economists had a somewhat more downbeat assessment. They saw risks to growth as “tilted somewhat to the downside,” risks to unemployment as “skewed somewhat to the upside” and risks to inflation as “weighted to the downside.” In other words, for each metric the Fed watches–inflation, unemployment and growth–its staff saw risks of economic underperformance.
Growth data have been disappointing of late, and some analysts have reduced their output estimates for the fourth quarter. For example, Macroeconomic Advisers, a forecasting firm, has pushed its estimate down from near 2% in mid-December to less than 1%. Construction and trade data released this week have been soft.
If the economy underperforms, the Fed could delay rate increases. Likewise, it could accelerate the pace of increases if the economy surprises with robust growth in the months ahead.
The next big test for the central bank is Friday, when the Labor Department releases its estimate of job growth and unemployment for December.
The Fed’s next meeting is Jan. 26-27, though a move that soon now looks unlikely.
Despite the reservations expressed at the meeting, Federal Reserve Vice Chairman Stanley Fischer, speaking on CNBC on Wednesday, said the market is underestimating how many interest-rate increases the central bank will undertake this year. Futures markets point to two rate increases, while Fed projections point to four.
This point was underscored by other Fed officials speaking publicly this week.
John Williams, president of the San Francisco Fed and a confidant of Fed Chairwoman Janet Yellen, earlier in the week said he could “easily see” the Fed raising rates three to five times this year. He expressed little concern about stock-market declines this week.
Loretta Mester, the Cleveland Fed president, said that the Fed’s internal projections “give a good sense” of where officials expect interest rates to go in the months ahead.