I have a theory that at least some people at the Fed are supporting interest rate increases not because they are worried about incipient inflation that must be nipped in the bud in advance under a regime of inflation targeting, but because they are looking over the horizon and worrying about a possible recession in the not-too-distant future, and they want to be able to have interest rates high enough that they can then engage in lowering them as a stimulative policy tool under the circumstances.If they are too low, then extraordinary measures will need to be used, and some of those measures may not be available in the future.
This theory is based on nothing solid at all, nothing.I think that those who may be thinking this (and my likely candidate(s) would be people at the very top) are constrained in speaking openly due both to the current institutional arrangement of consensus decisionmaking within an established inflation targeting system with a 2% inflation target, not to mention pressure not to talk about possible future dangers.The current line is that the economy is doing well, and certainly it is on the standard measures of unemployment and inflation, even if the former could be better and wages could be rising more rapidly.Indeed, it is this good performance that is supposedly underlying the moves to raise interest rates and possibly “normalize†the balance sheet (which I doubt there will be too much action on).But my theory is that for some of them it is a matter of trying to “normalize†on interest rates as well while the possibility of normalizing is possible, while the economy is doing fairly well and one can raise them without obviously slowing things down noticeably, so that indeed there will be the ability to lower them again in the future when necessary.
He did not put this theory forward, but it was reading the recent column by Larry Summers that appeared in the Washington Post on Monday was been linked to by Mark Thoma today (unable to make that link, sorry) and also can be gotten to at larrysummers.com/2017/08/14/why-the-federal-reserves-job-will-get-harder.He is focused on the upcoming ending of the term of his rival as Chair of the Fed, Janet Yellen, and is worried about who Trump will pick and what will happen.While stating that he would have “preferred a slower pace of interest rate adjustment,†he bottom lines that “Overall it has done well in recent years†(even though he did not get picked to be Chair).
