Meet the New Rate, Same as the Old Rate

In a move as surprising as the sun rising in the East, the Federal Reserve Board’s Federal Open Market Committee kept interest rates where they have been for the past 10 months.

With inflation still running above the Fed’s self-imposed 2% target and economic uncertainty in the air, the decision was not unexpected. In a press conference following the end of the two-day meeting April 30 and May 1, Fed Chairman Jerome Powell was quick to reiterate the perspective of central bankers.

“Inflation is still too high, further progress in bringing it down is not assured and the path forward is uncertain,” he said in his opening statement to media. “Restoring price stability is essential to achieve a sustainably strong labor market that benefits all.”

This has been Powell’s mantra since the Fed began raising interest rates in 2022 to ease inflationary pressures and there is no sign that is going to change anytime soon. The fixation on the 2% inflation target is the central tenet of Fed policy, even as the rate of inflation has been on a downward trend for several months.

It is important to note that when Fed officials talk about inflation, they aren’t just looking at the current rate but at future expectations as well.

“Although some measures of short-term inflation expectations have increased in recent months, longer-term inflation expectations appear to remain well-anchored, as reflected in a broad range of surveys of households, businesses and forecasters, as well as measures from financial markets,” Powell said in his remarks.

That begs the question as to why expectations of inflation matter. When baseball fans look over their favorite team’s record and peruse the upcoming schedule, they develop expectations of how successful the team will be over coming weeks and months. And while that effects their general state of fan happiness, it does not have any impact on the actual performance of the team on the field.

So why do consumer fears about inflation or business expectations of the state of the economy six months from now factor into Fed decisions on monetary policy? We are led to believe that Fed policymakers carefully scrutinize the economic data, looking at all manner of statistics to gain a solid understanding of the state of the economy before making policy moves. In a world where data-driven solutions are the stuff of advertising campaigns and business advice, it is a bit discouraging to see the nation’s central bankers effectively making interest rate decisions using the digital equivalent of a crystal ball.

Basing monetary policy decisions that will have an impact across the economy from Wall Street to Main Street on survey data of inflation expectations is an analog process in a digital world.

When it comes to the state of the economy and the outlook for the future, the general tone of those expectations leans hard toward the pessimistic side. Economic forecasting is difficult at best and while the statistical models used by economists are not perfect, they are at least not influenced by emotional reactions to the fluctuations of a modern economy. And yet we seemed to have entered a period where economic and fiscal decision making is based as much on intuition and feelings as it is on hard data.

Powell made that clear in his statement after the FOMC meeting earlier this month.

“We have stated that we do not expect it will be appropriate to reduce the target rate for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward 2 percent,” he said. “So far this year, the data have not given us that greater confidence.”

As the economic world moves forward and the Fed remains stuck on feeling better about making a monetary policy move, it is likely consumers and business owners may lose some confidence in the Fed’s policy decisions and lower their expectations of the health of the economy.