Nearly All Monetary Rules Say The Fed Should Raise Rates
By Matthew Schaffer, American Institute For Economic Research
The Federal Open Market Committee is widely expected to leave its policy rate unchanged this week, with the CME Group FedWatch tool implying a 98 percent probability that the federal funds rate will remain within its current range of 3.5 to 3.75 percent.
At the last FOMC meeting in April, there was a reasonable case for remaining patient and keeping policy steady. A negative supply shock stemming from conflict in the Middle East had pushed inflation higher, but monetary rules based on nominal spending suggested that policy was broadly in the right place. Nearly two months later, that case has weakened. Inflation has continued to accelerate, supply disruptions have lingered longer than many expected, and even some of the rules that previously supported holding steady are now tilting toward tighter monetary policy.
What the Rules Suggest
The latest Monetary Rules Report from AIER’s Sound Money Project shows that the Fed’s current policy rate falls below the range recommended by leading monetary rules. Eleven of the twelve estimates in the Report indicate that the Fed should raise its policy rate at the upcoming meeting.
The Taylor Rule is the most commonly referenced monetary policy rule. It says that the Fed should set interest rates higher when inflation runs above two percent and lower when economic activity or employment fall below sustainable levels. Using the most recent data available, the original version of the rule points to a federal funds rate of 5.91 percent, suggesting that current policy is far too accommodative. A modified version that minimizes interest rate volatility and accounts for forecasts of future inflation implies a policy rate of 4.11 percent. Even that more tempered version points to a 25- to 50-basis-point increase at the upcoming meeting.
Rules based on nominal GDP, or total dollar spending in the economy, suggest rates somewhat closer to the current 3.5 to 3.75 percent range. In April, those rules offered the strongest case for...(READ THIS WHOLE ARTICLE 100% FREE HERE).