The Federal Reserve just made a big decision to do nothing. Or maybe it’s better to say that it decided to do something later.
The Fed held its October meeting today, and it left interest rates unchanged. That’s even though inflation is still higher than its target, and the latest readings came in hot. Yet markets see a better-than-80% chance of a rate hike at the next meeting in December. So today’s real decision was probably to delay a rate hike by six weeks.
Chair Kevin Warsh’s explanation is that the Fed wants to see how September’s rate hike works its way through the economy. In his telling, the “monetary medicine” is starting to work.
Honestly, I’m a little puzzled. Why put off till tomorrow what you can do today?
Three is bigger than two
Here’s the quick recap. The Fed’s preferred measure of inflation is called the PCE deflator (the initials stand for Personal Consumption Expenditures). That’s up 3.4% over the year through August. Core PCE, which excludes food and energy, is up 3.0%. And CPI, which is probably the best description of changes in your cost of living, is up 3.7% over the year through September. You may notice that all of these start with a three, and the Fed’s target is two.
In September, the Fed raised interest rates for the first time since 2023. It did that because inflation was above target. Since then, the news has been a little more discouraging.
Slow-release financial medicine
Economists often say that monetary policy works with long and variable lags. That means that a rate hike is slow-acting medicine. It takes months to work its way through the economy.
That’s the heart of Warsh’s case for waiting, but I think it cuts the other way. September’s hike was just six weeks ago, and it’s the only one we’ve had in this cycle. It’s far too early for it to have done much to inflation. Watching to see if medicine this slow works on a first dose increases the risk that the second dose comes too late.
And that’s the usual worry about central bankers. Not that they’ll move too fast, but that they’ll move too late, only acting once inflation is already running hot. If the Fed knows there’s a strong case for raising rates next month then it knows there’s a strong case for taking that dose of monetary medicine today. That’s just good medical economic timing.
Let’s go one level deeper. What really matters for the economy is what’s called the real interest rate. That’s the interest rate, adjusted for inflation. When inflation comes in hotter than expected (as it has lately), the real rate implicitly falls if the Fed doesn’t change anything. Just keeping the real interest rate where it was a month ago may have required raising the nominal rate. The Fed didn’t do that.
Fed chair Kevin Warsh said at Jackson Hole that he doesn’t think policy is slowing the economy. Interest rates may even be below neutral. If inflation is too high, and we haven’t tapped the brake, I’d have thought that’s as good a time as any to work on slowing it down.
Some future changes to timing
There was other Fed news today. Warsh announced that the Fed will reduce how many of these rate-setting meetings it holds each year. Right now it’s eight, next year it’ll be seven, and in 2028 it’ll be six. The Fed will still meet those other dates. The Committee will just spend that time working on broader strategy, without actually talking about whether to raise or lower rates.
Strategy is good! But here’s my worry. Past chairs could move markets between meetings using a well-placed hint, which gave them something like 16 chances each year to steer rates. Silent Kevin is clear that he doesn’t do forward guidance. So he’s going from many rate-setting opportunities to six. That seems like a radical change.
Now, imagine the economy stalls, and it’s two months to the next meeting. By the time that meeting rolls around, a few committee members are unsure about what to do, so they punt to the next meeting. Before you know it, monetary policy is running months behind the economy.
It’s true that the Fed has the power to act between meetings. It did that during COVID and during the financial crisis. But those moves are usually reserved for times of emergency. And they’re not something the Fed is likely to want to do because emergency meetings are, well, emergencies. And who wants to look panicky? With fewer scheduled meetings and a rule-minded chair, I wouldn’t expect many of those to pop up.
Cleveland Fed president Beth Hammack, who dissented in favor of a hike, has argued for the opposite approach: smaller, more frequent changes that are easy to reverse. Lisa Cook dissented too, her first dissent as a Fed governor, a week before the president’s handpicked panel hears his case for firing her.
About that calendar
It’s hard to look at today and not think about the midterms. Markets seem sure the Fed needs to raise rates. But the Fed decided: Not today. And the next meeting falls conveniently after the election.
Historically, the Fed hasn’t hesitated to raise rates right before the election if the economy needed it. That’s consistent with the view that the best way to show you’re independent is by acting independently.
The decision to delay isn’t necessarily politics, and I think today’s decision is defensible. But it’s defensible only if it’s based on a coherent argument. That argument exists, so let me make it. Higher energy prices are a supply shock: prices rise, then they stop rising. The result is a temporary — dare I say transitory — blip in inflation, which quickly fades. If that’s the theory the Fed’s working with, I’d love to hear Chair Warsh make the case for it. If instead this is monetary policy driven by hope — he’s hoping the inflation rate comes down — then count me as unconvinced.
The good news is that the economy will probably get the rate hike it needs in December. It will just get it later, and given the lags, later costs something.
Today didn’t tell us much. Silent Kevin said that the medicine is working, and he still remains hard to read. The Fed did nothing, and markets expect it to do something in December. The courageous move would have been to do it today.
Why did the Federal Reserve kept the federal funds rate unchanged today, diverging from the Bank of Canada's policy move raised its benchmark policy rate by 25 basis points to 2.50% today? This marks the central bank's first rate increase in over three years (since July 2023), While central bank decisions are fundamentally driven by domestic economic indicators like inflation and labor markets, an interesting cultural parallel can be drawn to how both nations measure progress: Canada fully embraces global standardization via the metric system, while the breaking a long streak of holding the rate steady States remains exceptionally committed to its own traditional systems of measurement.
Just as Canada adopts global metric standards to seamlessly integrate with international commerce, the Bank of Canada often moves swiftly to align its monetary policy with global economic shifts. The U.S. maintenance of unique measurement units mirrors the Federal Reserve's mandate to prioritize domestic data over international trends, chartings its own path regardless of global peer actions.
“You can always count on the Americans to do the right thing, after they have exhausted all the other possibilities. Winston Churchill
Like Churchill my point is sarcasm.
I suppose Kevin is acquiescing to the White House, with back channel orders to keep the rate as is. But that will backfire. Today was the day, just unfortunately the midterms are next week.