Dynamic concept Monetary policy

No rate hike next week

The Fed has a mandate to maintain inflation at its target of 2%. There are a number of ways to measure inflation. From time to time these different measurements do not show a consistent picture of inflation, in status and on trend.

The dynamic behavior of inflation can be described by a feedback control model. The control target is inflation within the goal of 2%. The feed back signals are the measures of inflation, a familiar item is consumer price index (CPI). The CPI is reported monthly in terms of increase/decrease month over month and year over year.

The U. S. Fed uses core inflation within the CPI as its operational target. The core inflation is the portion that excludes volatile items such as food and energy. The benefit is that monetary policy does not have to change more often to respond to those price volatilities that have much shorter time constants. The core inflation in August was 0.3% over July, the biggest gain since this year. Detail examination however, showed that the strong gain reflected sharp increase in medical care prices.

Due to large lag between Fed policies and their effect on the economy, the Fed has recently relied more on inflation expectations as inputs to its monetary policies. University of Michigan reported Friday that consumer expectation on future inflation softened in August. The survey showed that Americans expected inflation 2.3% over next year, the weakest in six years.

Last week retail sales were reported decline in August for the first time since March and manufacturing production slipped. It appears to me that the economic growth is saturating after seven years’ recovery.

Low unemployment rate and soft inflation could complicate the FOMC meeting next week. I do not think the Fed would risk to tighten the monetary policies too early, despite “a case for an increase in the federal funds rate has strengthened in recent months” ([1]).


[1] Janet Yellen, the Federal Reserve’s monetary policy toolkit: past, present and future, Jackson Hole, Wyoming, August 26, 2016.