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Raising rates, even a little, will slow the economy and slow progress in reducing unemployment
// Economic Policy Institute Blog
This week the Federal Open Market Committee (FOMC) will meet to decide whether or not to raise interest rates. By now this is a familiar debate. Some (call them hawks) argue that rate hikes are needed to slow the pace of economic growth and slow progress in reducing unemployment in the name of combating potential inflation. Others (call them doves) argue that we should not tighten until we're absolutely sure that genuine full employment has been locked in. The past years' evidence argues strongly that the doves are right.
Let's start with the Fed's own projections, which some Fed officials recently pointed to during a meeting with the Fed Up coalition to claim that interest rate increases were not meant to slow the economy or raise unemployment.
The table below shows the Fed's current projections for the unemployment rate and other variables. They forecast that it will move from today's 4.9 percent to 4.7 percent in the last three months of this year, and then fall further, to 4.6 percent for 2017 and 2018. After this it rises (after some unspecified time) to its long-run equilibrium of 4.8 percent. This 4.8 percent long-run rate is essentially the Fed's estimate of the "natural rate of unemployment"—the lowest rate the economy can stay at without sparking an acceleration of inflation (this acceleration terminology is key: it's not just inflation rising from 1.5 percent to 2.5 percent, it's inflation that rises from 1.5 percent to 2.5 percent to 3.5 percent to 4.5 percent and so on). Importantly, in the Fed's forecast, the unemployment rate falls over the next three years even as the projected federal funds rate is moved steadily up. By 2018, the 4.6 percent unemployment coincides with a 2.4 percent federal funds rate (it is just 0.25 percent today).
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