17 September is the date. We find out then, at the end of the Federal Reserve Open Market Committee (FOMC) meeting, whether or not the benchmark Fed Funds Rate is raised. Nearly everyone agrees that it’s likely to happen, either in September or in December. But trillions of dollars will be riding on the moment when the press release is issued on the Fed’s website telling people what exactly is happening.
Except for one thing – we won’t know exactly what will happen because the stock and bond markets may react in odd ways that are not easily predicted. The same is true for currency traders.
What it all comes down to is whether or not the FOMC thinks it is a good time to start or not. The arguments for and against are fairly easily summarized, but to Barataria the case is strong for a rise – especially if the net medium-term effect is that consumer rates go down.
Discussions about the need to raise rates are more fun than many public debates because they don’t fall neatly along party lines. The more business minded Republicans tend to think that rates should go up sooner rather than later to end the distortion of the market, while Tea Party types tend to be skeptical of anything that the Federal Reserve does. Similarly, establishment Democrats tend to believe that a rate increase is inevitable while the progressive wing thinks of it as a pro-establishment job killer.
In all cases, however, a general distrust of data that suggests that we are no longer in a dire emergency is usually discounted. August’s reading of a 5.1% unemployment rate is usually met with skepticism that the numbers are all cooked. The public seems to understand what the press doesn’t – that the “headline” unemployment rate (aka U3) is rather meaningless.
The argument using the more comprehensive U6 unemployment, which includes everyone not working as much as they’d like, probably makes the case better than anything else. The fall to 10.3% in August doesn’t sound great, but it’s a lot better than it has been:
Note that we are finally down below the worst peak after the official recession of 2001, and that U6 has never gone below 6.8%. We can’t call this the dire emergency that created a zero Fed Funds Rate any longer. Granted, that’s about 5 million people more that don’t have the hours they want, so there is still a problem. But what is a quarter point or so in the grand scheme of things?
It’s worth revisiting the Mankiw Equation, a rough approximation of the Fed’s target. Named for its inventor, Harvard Professor Greg Mankiw, it has done a decent job of tracking the Fed Funds rate as far back as you want to go.
Federal funds rate = 8.5 + 1.4 * (Core inflation – Unemployment)
This balances the twin responsibilities of the Fed to maximize employment and keep inflation under control. The calculation, in blue, is shown against the actual Fed Funds rate in red:
Note that we should be, by this approximation around 3.6% today. And that the last time U6 was in the low 10% range the Fed Funds Rate was about 1%. We can take this as a reasonable range that the Fed is likely to target.
No matter what, it’s a long way from zero.
So how does this play out as an argument? The idea that rates have to go up should be taken as a given. Yes, the headline U3 unemployment rate is rather meaningless, so we should use the best number we have – the more comprehensive U6. That tells us that a small rate increase makes sense as we are clearly moving towards a more normal situation.
Both sides of both parties do have a point, but there is a plenty of wiggle room between zero and 1%. A gentle start to it now only makes sense from any perspective.
But will this argument win out in a week? Stay tuned to find out.