The Federal Reserve raised interest rates from near zero in 2015 after keeping them at lows for years following the 2008 global financial crisis. Transcripts of their political discussions published on Friday show how difficult this decision was.
The debate that was going on at the time is particularly relevant now when the central bank has again cut interest rates to virtually zero, this time to combat the economic downturn caused by the pandemic. Concern officials expressed about the 2015 rate hike – that inflation would not rise and that the labor market had to continue to heal – turned out to be forward-looking in ways that will affect policy making in the years to come.
The Fed, chaired by Janet L. Yellen, raised its key rate in 2015 when the unemployment rate fell. Officials feared if they waited too long to raise borrowing costs it would trigger economic overheating, which would drive inflation up and prove difficult to contain.
The logic at the time was that monetary policy operates with “long and variable” lags and that it is better to normalize policy gently before real rapid price gains appear.
But even then, not everyone on the Fed’s Federal Open Market Committee was happy with the plan. When the decision to hike rates was taken in December, Governor Lael Brainard seemed to question it, arguing that the labor market still had room for expansion and that inflation was missing the committee’s 2 percent target. She finally voted in favor of the decision together with Ms. Yellen and her political decision-makers.
“The latest price data gives little indication that this undershooting of our target will end soon,” said Ms. Brainard, according to the protocol on the inflation at the time. This, coupled with the risks of slowing overseas, made them “somewhat more important to the possible regrets associated with tightening too early than the potential regrets associated with waiting a little longer”.
When Ms. Brainard said she would vote in favor of the increase anyway, she said she had “put a very high premium on ensuring the credibility of monetary policy” and recognized the thoughtful process Ms. Yellen and staff in planning a change had gone through politics. She suggested in 2019 that hike rates in 2015 was a mistake and that “a better alternative would have been to delay the start until we met our goals”.
The then vice-chairman Stanley Fischer explained briefly and succinctly why the committee was moving.
“Why move now?” he said. “Firstly, as the chairman emphasized, there is a delay in our actions taking effect. Second, there is some evidence of accumulating problems with financial stability. And third, the signal we are sending will reinforce the fact that our economic situation is continuing to normalize. “
Jerome H. Powell, then governor of the Fed and now chairman, said at the time that the remaining scope for labor market gains was “likely modest,” but highly uncertain, and that participation rate – measuring people who work or look for work – could Rebound.
“I’m in no hurry to conclude that the current low turnout reflects unchanging structural factors,” said Powell. “I think it is likely necessary for the economy to be above trend for some time to make sure inflation hits our 2 percent target.”
The more reluctant attitudes aged comparatively well. In the period since then, many economists and analysts have viewed the Fed’s preventive rate hikes as possibly premature. The unemployment rate continued to decline for years, but as more workers entered the labor market, wages rose only moderately. Price gains remained stable and, in fact, a little softer than Fed officials had hoped.
As a result, the Fed has re-evaluated its monetary policy. Mr Powell said last year that he and his colleagues would now focus on “deficits” in full employment – worrying only when the labor market is weak, not when it becomes strong while inflation is contained.
They no longer plan to hike interest rates to stave off inflation before it shows up, officials said, paving the way for longer periods of lower interest rates.