Fed Makes No Change to Interest Rates, Despite Inflation Rise

Posted: 12 December 2019 5:04 pm

Pile of hundred-dollars bills.

Even though inflation has risen above the Fed’s 2% target, it has indicated that there will be no change in interest rates unless there are signs of the increase being persistent.

On Wednesday, the Federal Reserve opted to make no changes to its benchmark rate, breaking a trend of 3 consecutive decreases. In a statement, the Federal Open Market Committee has stated that monetary policy is likely to stay where it is for the foreseeable future, barring new developments.

“The Committee judges that the current stance of monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective,” the statement said.

This is despite an increase in inflation. The US Department of Labor’s Bureau of Labor Statistics reported Wednesday that the consumer price index grew more than expected in November. The CPI rose by 0.3%, compared to the 0.2% expected. This brought inflation to a 12-months high of 2.1%. This is significantly lower than the six-year high of 2.9% in 2018.

Typically, the Federal Reserve raises interest rates to control inflation. The idea is that low interest rates will encourage borrowers to secure new loans, which would increase the money supply. An increased money supply means that consumer spending also increased, inflating prices via supply and demand. Too much spending, however, may trigger heightened inflation, which weakens the dollar’s purchasing power.

The BLS reported that the cost of rent and medical care both increased by 0.3%. Food, clothing, education, and used vehicles also saw modest price increases, while gasoline prices fell less than what is typically expected for this time of year. New car prices and airfares also fell this month. This is against no change in real hourly wages for the month and a 1.1% increase for the year.

The current inflation rate is slightly above the Fed’s current target of 2%. The Fed is currently reviewing its long-term policy strategy. Speculation on where the Fed may go include adopting a “makeup” strategy, which would allow the Fed to tolerate an interest rate above target if and for as long as the target has been below target, and an increased target of 4%.

Fed Chairman Jerome Powell has soundly rejected the idea of raising the target. “If you said we are raising the inflation target to 4%, what would be the effect of that? Where is the credibility in that, really? You haven’t been able to get it to 2%,” Powell said.

The inflation number is set against a backdrop of 26,000 jobs being added to the economy in November and an unemployment rate of 3.5% — the lowest in a half-century. This news has relieved some fears that the nation may be heading toward a recession soon.

“The economy appears well positioned to find its footing and extend the expansion into 2020,” Jim Baird, chief investment officer at Plante Moran Financial Advisors, said to Reuters.

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