March 15, 2017 Reading Time: 2 minutes

The Federal Reserve raised its target for the federal funds rate by 25 basis points to a range of 0.75 percent to 1.00 percent.  The move was the third rate increase since December 2015. The current pace of policy normalization remains well below previous tightening cycles.

The Summary Economic Projections (SEP), the survey of Fed members on their outlook for the economy and monetary policy, was nearly identical to the previous SEP released in December 2016. In the latest SEP, Fed members expect real Gross Domestic Product (GDP) to grow at a 2.1 percent pace in 2017 and 2018 compared to a long-run average of 1.8 percent. The unemployment rate is expected to be 4.5 percent in the current year and next year, slightly below the long-run average of 4.7 percent. Expectations for the Personal Consumption Expenditure (PCE) price index to increase 1.9 percent this year and 2.0 percent next year and over the long run.

The key figures from the SEP remain the expected progression of increases in the federal funds target. The median expectation is unchanged for 2017 and 2018, with targets of 1.4 percent and 2.1 percent, respectively. These targets imply two additional rate increases in 2017 and three in 2018. The critical implication is that the Fed is staying the course for a gradual removal of accommodation.

There are supporters and critics for this approach. Supporters argue that the economy is still growing at a slow pace and price measures are only gradually approaching the 2 percent goal, and much of the recent increase is due to energy. Labor costs are growing at a slow, though gradually accelerating pace and uncertainty surrounding not only global growth but fiscal policies under the new Trump administration all support a gradual approach.

Critics argue that the enormous amount of reserves in the financial system could lead to a surge in inflation and that abnormally low interest rates are distorting some market functions while penalizing savers and benefitting borrowers.

The reality is all those arguments are true. The Fed is attempting to balance these arguments. It is critical for the Fed to stop distorting market functions and allow a reasonable return on capital. However, history has shown that abrupt policy changes can cause investors to panic and could put the economic expansion at risk. The prudent course is to continue the gradual pace of policy normalization.

Once the federal funds rate is back to a more normal level, my hope is that the Federal Reserve will become much less active in attempting to manage the business cycle and allow market forces to play the dominant role in guiding economic activity. My view is that the complete absence of sensible fiscal policy created a vacuum that caused the Fed to become more involved and more prominent than necessary. It is essential for the Trump administration to develop fiscal policy that is responsible, sustainable, and without disruptive lobbyist distortions. Sound fiscal policy that creates a supportive environment for free market forces combined with minimal monetary policy intervention is the best way for the economy to reach full potential.

Robert Hughes

Bob Hughes

Robert Hughes joined AIER in 2013 following more than 25 years in economic and financial markets research on Wall Street. Bob was formerly the head of Global Equity Strategy for Brown Brothers Harriman, where he developed equity investment strategy combining top-down macro analysis with bottom-up fundamentals.

Prior to BBH, Bob was a Senior Equity Strategist for State Street Global Markets, Senior Economic Strategist with Prudential Equity Group and Senior Economist and Financial Markets Analyst for Citicorp Investment Services. Bob has a MA in economics from Fordham University and a BS in business from Lehigh University.

Get notified of new articles from Robert Hughes and AIER.
AIER - American Institute for Economic Research

250 Division Street | PO Box 1000
Great Barrington, MA 01230-1000

Contact AIER
Telephone: 1-888-528-1216 | Fax: 1-413-528-0103

Press and other media outlets contact
[email protected]

Editorial Policy

This work is licensed under a 
Creative Commons Attribution 4.0 International License,
except where copyright is otherwise reserved.

© 2021 American Institute for Economic Research
Privacy Policy

AIER is a 501(c)(3) Nonprofit
registered in the US under EIN: 04-2121305