The Federal Reserve's key interest rates have been very low for a long time now, and the labor market is in at least okay shape, so calls for tighter money are getting louder from almost every corner. One huge problem for these calls, though, is that the point of tight money is supposed to be to control inflation. And right now inflation is way below the Federal Reserve's 2 percent target, and it's been below that target for years.
But a lot of people want to raise rates anyway, and they're making two somewhat dubious arguments to bolster their case. One is to say that we should ignore the inflation rate the Fed has set as its target, and use another one instead. The other is to make misguided assertions about the ways interest rates influence the economy, in order to gin up non-inflation rationales for tighter money.
The Fed is below target by any measure
On inflation metric funny business, Rich Miller has a piece in Bloomberg titled "The Fed Is a Lot Closer to Its Target Using This Inflation Measure."
The measure in question is the Dallas Fed's "trimmed mean" PCE deflator. This is part of a family of alternate inflation measures that attempt to improve on the instability of overall price indexes. The oldest and best-known of these are so-called "core" inflation measurements that simply throw food and energy prices out of the basket on the grounds that food and energy prices are very unstable. Trimmed mean is a more sophisticated way of doing the same thing — each month you throw out the fastest-growing and fastest-falling prices, "trimming" the inflation index to ignore the impact of weird outliers.
Of the different approaches along these lines, I'm most a fan of the Cleveland Fed's median CPI.
But whatever you think of these alternate indexes, here are two key points:
- The Fed has given itself a mandate to target 2 percent inflation as measured by the PCE deflator. Just switching ad hoc to different indexes will undermine predictability, stability, the rule of law, etc.
- All the different indexes show inflation well below 2 percent!
This last one is important. It's true that using Trimmed PCE shows we are undershooting 2 percent by only a modest amount, while Median CPI and Core PCE both show undershooting by a slightly larger amount, and pure PCE shows massive undershooting. But directionally, all these measurements show the same thing — inflation is not too high, so if the point of higher interest rates is to control inflation, there is no case for higher interest rates.
Low interest rates don't stymie investment
Meanwhile, over in the Financial Times, Danielle DiMartino Booth offers an even more bizarre argument for higher interest rates. She accuses the Fed of "ignoring rising inflation" even though inflation is not, in fact, rising.
And then she argues that low interest rates are causing companies to not invest:
In the meantime, Fed policy has facilitated bad behaviour. Corporate chieftains, a breed long plagued with short-termitis, have been encouraged to trespass further by the siren call of cheap money. Why bother investing in the long term when it is so much more fun, to say nothing of more lucrative, to buy back shares, reduce share count and puff up profits?
The trend toward executives using borrowing to finance share buybacks rather than investment appears to be real (see JW Mason's research for more on this), but it has nothing to do with the current state of interest rates. An executive has to make the calculation, "Is it better for the value of my stock options to invest this borrowed money or to spend it on share buybacks?" Interest rates plausibly influence the quantity of borrowing that companies do, since lower rates make borrowing cheaper. But there's no reason for them to influence the split between buybacks and investment.
It's time to admit we don't have a problem
Economic commentators seem to have a great deal of difficulty with this, but it's time to admit that at the moment the United States simply isn't facing a serious business cycle problem. Unemployment is on the low side, but so is inflation. Cheap commodity prices are giving everyone a boost, there are a lot of able-bodied adults who may or may not rejoin the workforce in the near future, and after a long stretch of weak wage growth there's room for people to get some raises without corporate profits being squeezed to an untenable level.
Things are basically fine, and while a small increase in interest rates almost certainly wouldn't be ruinous, there's also no reason to do it.