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U.S. Federal Reserve Finally Raises Rate

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Federal Reserve Chairwoman Janet Yellen speaking at a press conference in Washington on the day the Fed raised its short-term rate.

After forecasting a minimum of three rate increases for 2016, the Fed finally does raise its benchmark rate 25 basis points in its first meeting after the election of Donald Trump as President. 

The U.S. Federal Reserve raised its short-term federal funds rate by 1/4 percentage point on Wednesday bringing the all-important benchmark rate to 0.75, its highest level since before the Fed took interest rates to zero in December 2008, the year of the credit crisis.  It was the first rate hike since December 2015 and only the second since 2006.  

Fed Chairwoman Janet Yellen said in a press conference in Washington that she expects the economy to continue to perform well.  "Economic growth has picked up since the middle of last year," said Yellen, who was nominated by President Barack Obama in October 2013 to succeed two-term Chairman Ben Bernanke.  "Household spending continues to rise at a moderate pace, supported by income gains and by relatively high levels of consumer sentiment and wealth." 

Ms. Yellen acknowledged that business investment, the supply-side of the economy, remains "soft" but then went on to say that the Fed expects the economy "will expand at a moderate pace over the next few years."  U.S. economic growth has aveaged 2% or less in all eight years that President Obama has held office.  Third quarter GDP came in at 3.2% just two weeks ago, but fourth quarter GDP is forecast to be less than 1%. 

Past Forecasts

In December of last year, when the Fed last raised rates, median projections by Fed officials forecast a federal-funds rate at 1.375% at the end of 2016, implying four quarter-percentage increases in 2016, according to an anlysis of Fed projections by the Wall Street Journal.  Ms. Yellen herself gave an upbeat assessement the day after the Open Market Committee voted unanimously to increase rates.  "We believe we have seen substantial improvement in labor market conditions and, while things may be uneven across regions of the country and different industrial sectors, we see an economy that is on a path of sustainable improvement," Yellen said in December 2015.

But at the March 2016 policy meeting, interest rates stayed at .50% with the expectation that the Fed would make two rate increases for a half a percentage point rather than the full point increase originally predicted in December 2015.  Ms. Yellen sought to explain the shift over concern for the global economy.  "The major thing that has changed between December and March that affects the baseline outlook is slightly weaker projected pace of global growth," Yellen said.  "Global developments pose ongoing risks."

In her speech yesterday, Ms. Yellen forecast inflation at 1.5% this year, 1.9% percent next year and 2 percent in 2018 and 2019.  As a result, she made new projections for future increases in interest rates.  "The median projection for the federal funds rate rises to 1.4 percent at the end of next year [2017], 2.1 percent at the end of 2018 and 2.9 percent by the end of 2019.

Keynsian Economics

During questions from reporters, Ms. Yellen was asked by Steve Liesman of CNBC if "individual and business tax cuts increase the productive capacity of the economy?  Yellen, a liberal economist who spent most of her career in academia responded: "Policies that would improve productivity growth would include policy changes that enhance education, training, workforce development; policies that spur either private or public investment to enhance the quality of capital in the United States that workers have to work with; and policies that spur innovation or competition or the formation of new firms."

In a notable exchange, Christopher Condon of Bloomberg News asked Ms. Yellen if it might be possible to repair damage to the labor force during the recession by running what she termed a "high pressure economy?"  A high-pressure economy would imply a high tolerance for inflation and tight labor markets.  Ms. Yellen answered that she never said she was in favor of running a high-pressure economy.

Yet in a speech in October 2016, Ms. Yellen said the following: "If we assume that hysteresis is in fact present to some degree after deep recessions, the natural next question is to ask whether it might be possible to reverse these adverse supply-side effects by temporarily running a high-pressure economy with robust aggregate demand and a tight labor market." 

Look out.  This would represent the latest effort by Keynsian economists to keep interest rates low even in an inflationary environment.