Here’s a Way Yellen Can Raise Rates Without Spooking Markets

There are risks to the Federal Reserve raising rates this week and risks to standing pat

 

Federal Reserve policy makers are in a tough spot. If they raise rates at their meeting this week, they know they could stir trouble. But if they don’t, they risk forestalling a day of reckoning they believe must come.

One way out: overhaul the framework they have put forward for setting policy.
A month ago, the Fed was on course to tighten policy this week, but financial-market turmoil has altered that call. Where in August 82% of economists surveyed by The Wall Street Journal expected the Fed to raise its target range on rates at its two-day meeting ending Thursday, that number was cut to 46% in this month’s poll.
The divided response from economists is reflective of a Fed that itself is divided. Some members of the central bank’s rate-setting committee would like to delay a rate increase until next year. That isn’t just because of the financial-market environment. It also is because the interrelated effects of a stronger dollar, lower commodity prices and economic weakness overseas look to further chill inflation.

ENLARGE

In June, Fed policy makers’ projections centered on an expectation that consumer-price inflation excluding food and energy would be just 1.3% to 1.4% in the fourth quarter from a year earlier. Incoming data suggest they should take that estimate even lower when they update projections this week.

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But policy makers also need to raise their projections for economic growth. In June, these centered on an expectation that fourth-quarter gross domestic product would be up 1.8% to 2% on the year, while economists’ current estimates put growth at about 2.4%. Their unemployment rate projections centered on a fourth-quarter average of 5.2% to 5.3%. Last month, the unemployment rate fell to 5.1%.
The steady economy and strengthening job market is one reason some at the Fed would prefer to raise rates now, and they view unsettled financial markets as a poor excuse for not acting. More generally, Fed officials may worry that not moving on rates, but saying that a rate increase is really, really close, may only serve to keep markets unsettled.
In seeking to corral these competing views, Fed Chairwoman Janet Yellen could craft a consensus in the following way: Get it over with and raise rates by a quarter point. But within its postmeeting statement commit to hold off on further increases until inflation is picking up, and underscore that with a move lower in interest-rate projections for the end of next year. In June, these centered on a range of 1.5% to 1.75%.
Such a move would help limit any bad response by markets. And given the backdrop of ultralow inflation, it would probably reflect where policy is heading anyhow.