Pundits are finally asking officials if the Federal Reserve is going to "raise rates." Federal Reserve (from here, Fed or the Fed) chairmen and "Governors" in fact do talk about their power to manipulate interest rates. The Fed is required by law to keep inflation under control (See Alan Greenspan, The Age of Turbulence, New York: The Penguin Press, 2007, 178 & 179). Even people who don't follow business or financial news may have heard that the Dow Jones Industrial Average (DJIA) finally surpassed 36,000 (A book published in 1999 titled Dow 36,000 predicted that the DJIA would reach that height at some point). People don't normally call it inflation when the stock market reaches new height after new height as it's been doing. As former Fed chairman Alan Greenspan observed, "For most economists, price stability referred to product prices―the cost of a pair of socks or a quart of milk. But what about the prices of income-earning assets, like stocks or real estate?" The politicians are talking about inflation a lot, but they aren't necessarily upset about all rising prices. Stock prices can go up, and no one complains about it. The Fed, however, has to care if it wants any serious person to regard it as an inflation fighter. According to Greenspan, "we [the Federal Open Market Committee or FOMC] agreed that trying to avoid a [stock market] bubble was consistent with our mission" (The Age of Turbulence, 175 & 178). I am not suggesting that the stock market is in a bubble now. When people talk about "raising rates" today, I don't presume that they are the least bit worried about high stock prices. They are, however, looking for a remedy to the high consumer goods prices. As we'll see, some old remarks by John Maynard Keynes shed light on how the stock market, the Fed, and the price level are connected.
It may be ominous to note that Keynes wrote these words during what is now known as the Great Depression, but be careful not to draw any hasty conclusions:
With the Wall Street collapse in the autumn of 1929 one of the greatest "bull" Stock Exchange movements in history came to an end…. [T]he high market-rate of interest which, prior to the collapse, the Federal Reserve System, in their effort to control the enthusiasm of the speculative crowd, caused to be enforced in the United States … played an essential part in bringing about the rapid collapse. For this punitive rate of interest could not be prevented from having its repercussion on the rate of new investment both in the United States and throughout the world, and was bound, therefore, to prelude an era of falling prices and business losses everywhere. (John Maynard Keynes, A Treatise on Money Volume 2: The Applied Theory of Money, New York; Harcourt Brace and Company, 1930, 195 & 196)
People familiar with the twentieth century are familiar with the catchphrase "irrational exuberance." By the time Alan Greenspan spoke those words, all it took for a stock sell-off was the mere suspicion that interest rates would rise. Greenspan and the FOMC would eventually raise short-term interest rates after dropping hints that they would. They, like in the twenties, were concerned about "reining in the bull," but they didn't say so openly. The Fed or FOMC has a dual mandate: their goals are price stability and maximum employment. Whether or not they can indeed "serve two masters" is another question. If we want to be uncharitable, we can accuse them of focusing on one goal at the expense of the other. For example, in August, 2020, the Fed either ignored price stability or stretched the definition of those words beyond recognition so that it could focus on "job creation" (Nick Timiraos, "Fed Looks to Relax Targets in Fighting Inflation," Wall Street Journal 3 August 2020, A1). When one problem is taken care of, it frees them to focus on another problem (More accurately, when one problem seems to be taken care of. To be fair to the Fed, as recently as March 2021, a headline declared, "Inflation Risk: Little Now, but Some See Danger Ahead"[i]). Even if a problem isn't taken care of, the Fed can just focus on another goal as long as it doesn't deviate too much from the stated goals. For example, starting in 2012, the Fed "formally adopted the 2% inflation goal, a level it regards as consistent with healthy economic growth" (Ibid, A2). By 2020 (another election year… Interesting), it took "a more relaxed view by allowing for periods in which inflation would run slightly above the central bank's 2% target" (Ibid, A1) (If you are recalling a frog in boiling water, you are not alone). How the Fed deals with "price stability" seems to have a lot to do with who is in charge at a particular time. Greenspan's Fed actually wanted to preempt inflation. Just a month before it raised rates, Greenspan could acknowledge that "the economy was performing well," which apparently meant low inflation. Furthermore, Greenspan was aware that "the Fed had no explicit mandate to focus on the stock market" (Age of Turbulence, 175 & 178) In spite of the potential backlash (and the availability of good excuses for simply doing nothing), the Greenspan Fed raised rates anyway. One of Greenspan's reasons for doing so will be familiar to economists. In fact, Keynes noticed the phenomenon called "wealth effects" nearly a century ago. Anyone serious about combating inflation must take that phenomenon into consideration.
Even though (or, perhaps, because) the current Fed is relatively lax when it comes to inflation, a bond sell-off and "[m]oves in market-based measures of inflation" prompted concerns in early March, 2021 that the Fed would be forced to raise interest rates (Julia-Ambra Verlaine & Sam Goldfare, "Bonds Shake Up Stock Market's Faith in Low Rates" Wall Street Journal 1 March 2021, B6). We saw the DJIA briefly fall below 31,000 during the first week of March, but it came roaring back. The bondholders, however, could force the Fed's hand. Borrowers, including the U.S. Treasury, would have a problem selling bonds if the public is expecting perpetual high inflation. Bond yields would be bid up as borrowers hope to attract lenders. When bond yields go up, "other people take their money out of the [stock] market and buy bonds, and the [stock] market goes down" ("Adam Smith," Supermoney, New York: Random House, 1972, 50). If the stock market goes down, it will make inflation milder than it would have been because of wealth effects. As Greenspan explained, "we [the FOMC] were all aware of a 'wealth effect': investors, feeling flush because of gains in their portfolios, borrowed more and spent more freely on houses and cars and consumer goods" (Age of Turbulence, 165). Keynes, writing about the bull market of the nineteen-twenties found the idea of wealth effects to be quite intuitive: "Who can doubt that a man is more likely to buy a new motor-car if his investments have doubled in money-value during the past year than if they have been halved? He feels far less necessity or obligation to save out of his normal income, and his whole standard of expenditure is raised. For their paper profits and their savings out of current income are not kept by most men (as perhaps they should be) in entirely separate compartments of the mind" (A Treatise on Money Volume 2, 197, emphasis added). Is it any wonder that we are hearing complaints about inflation at the same time that the DJIA has reached its 36,000 figure milestone? You don't have to be a stock market bear to understand that the Fed can't finesse the meaning of "price stability" indefinitely. Even if the Fed believes that inflation is the lesser of two evils when compared to unemployment, the bondholders may revolt. Segments of the public may revolt too in some way (at the ballot box?) if prices of the goods they need continue to rise. When even the media is asking about (asking for?) rate increases, you have to admit that we are in unusual economic territory.
For the above reasons, I don't think that the question in the title is a sensible one. When pundits ask the question, it's understood that they mean "Will the Fed raise rates soon?" Of course, given that the former President, prior to his suspension from Twitter, used to tweet messages such as "The Federal Reserve should get our interest rates down to ZERO, or less…," it may not be out of the question for the Fed to never raise rates again. We live in unpredictable times, but I don't think monetary policy is totally up to the Fed's discretion. If inflation is not "transitory," as the Fed chairman reportedly said, then I doubt that the monetary authorities at the Fed will be able to delay the inevitable rate hikes indefinitely. If inflation keeps becoming undeniable, the Fed will have to do something about it or else lose all credibility with the public. The more practical question then is "When will the Fed raise rates?" Unlike Trump, Biden is supposed to be hands-off when it comes to monetary policy (See Greg Ip, "Inflation Risk: Little Now, But some See Danger Ahead" Wall Street Journal 2 March 2021, A9), but he is getting beat up politically over the issue of inflation. The Fed, as Greenspan put it, "does not operate in a vacuum" (Age of Turbulence, 178). You don't have to be conspiratorial to grasp that "the establishment" is fond of inflation. As Larry Summers so eloquently put it, "The prevailing zeitgeist is all about accepting and even being enthusiastic about higher inflation" ("Inflation Risk: Little Now, But Some See Danger Ahead," A1). Voters, however, don't seem to be enthusiastic about price inflation. It's ironic that the right supported a guy, Trump, who wanted to lower rates just a little over a year ago. That was then, and times have changed. Prices plummeted because of the pandemic and the lockdowns, and hardly anyone was worried about inflation then. Now, there does seem to be genuine public outcry about the rising costs of goods. The "working class" that we hear so much about could very well be losing more than they gain from the inflation. They may not have lobbyists, but each of them gets one vote, the same number that a billionaire gets. We've seen that people in rural areas can turn out to vote in record numbers, as they did in the recent Virginia elections. The establishment politicians may be more worried about their wrath than they are about preserving Fed independence. If it is indeed genuine, the populist revolt against inflation may be affecting Washington D.C. soon.
[i] Greg Ip, Wall Street Journal 2 March 2021, A1
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