The Federal Reserve may have to hike interest rates sooner than it thinks. The Federal Open Market Committee announced on Wednesday, as expected, that it is sticking with its near-zero target until 2015. But next month’s presidential election may change that.
It’s not a question of who wins the White House, even though the differences between the candidates on economic policy are substantial. Nor will any change necessarily be determined by whether Ben Bernanke remains as Fed chairman. After all, while Mitt Romney has said he’d ditch him and President Obama would probably keep him, Bernanke himself has indicated he may retire when his term ends in January 2014.
What will change, though, is the time horizon of economic policy. Once the election is over, policymakers are likely to adjust their focus to what should be done over the four-year course of the next presidential term.
In fiscal policy, the thought of four more years of deficits adding to the debt total may finally make lawmakers serious about deficit reduction. In monetary policy, short-term fluctuations in unemployment may become less salient; the long-term costs of current policies, in suppressing savings and risking an uptick in inflation, may become more salient. That would add pressure to increase rates sooner rather than later.
Minneapolis Fed President Narayana Kocherlakota last month suggested an early rate hike could happen when either inflation reached 2.25 per cent or unemployment fell below 5.5 per cent. That looks unbalanced: “core” consumer prices jumped 2 per cent in the 12 months to September while unemployment remains at 7.8 per cent. Indeed, Kocherlakota’s unemployment target is below some current estimates of full employment. Chicago Fed President Charles Evans’ more recent suggestion that rates should not move until unemployment falls below 7 percent or inflation exceeds 3 per cent looks more reasonable.
Setting such targets would be a good first step for the FOMC to prepare the world for rate hikes. That might not happen as early as its next meeting in December. But the days of avidly sticking to the current ultra-low interest rates may end sooner than expected.