Policy makers at the Federal Reserve disagree as they try to sort through the case for interest rate hikes. Some think that an increase should be deferred until the inflation rate resumes moving toward the 2% target; others remain comfortable with gradual raises in anticipation that the tightening labor market will increase inflation pressures.
The new complication is the increased likelihood of a fiscal stimulus package that reinforces growth. Investors still assume rates will rise only very gradually, as indicated by long-term yields in the bond market. These uncertainties and contradictory views may soon be resolved because inflation is likely to accelerate and that could be reinforced by an untimely fiscal stimulus.
Public statements suggest that a number of senior Fed officials would prefer to see evidence of faster inflation before they would be willing to follow up a nearly certain 25 basis-point rate hike at the upcoming December Federal Open Market Committee meeting. Most central bank officials speak openly of their surprise that inflation moderated over much of 2017 despite the progressive tightening of the labor market.
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The purpose of hiking rates is to contain brewing inflation pressures. So if inflation remains benign, there would be no satisfactory justification for the Fed to raise rates. Policy makers could simply allow unemployment to continue to decline. But almost all economists believe that joblessness cannot fall to zero without severe inflation pressures. The Phillips curve may have shifted, making it an imperfect policy gauge, but no one should expect that growing labor scarcity can be sustained without meaningfully faster inflation unless the laws of supply and demand have been repealed.
More recent data hint at a resumption of the rising trend in inflation seen before last spring. The last two core personal consumption deflator reports both came in at 0.2% per month, a 2.4% annual rate that is comfortably above the Fed’s 2% target. Wage inflation, the largest component of the cost of producing gross domestic product, has also re-accelerated, rising to 2.8% over the latest 12 months.