The Federal Reserve on Wednesday raised interest rates for the third time in six months, the latest sign that the central bank is eager to cool the economy and end the era of easy money that has been in place since the financial crisis.
“Normalization” is the Fed’s preferred term for this effort to return to prerecession policies. And while Wednesday’s quarter-point increase lifts the benchmark federal funds rate to between 1.0 and 1.25 percent, this is only the beginning.
On average, Fed members expect one more rate increase in 2017, followed by another three in 2018. That would bring the baseline interest rate above 2 percent, still below the long-term average but higher than it has been in nearly a decade.
At the same time, the Fed also plans to shed trillions in assets from its recession-fighting “quantitative easing” program. If that rings a distant bell, it was the Fed’s effort to goose the economy by buying up large caches of Treasury bonds and mortgage-backed securities, which kept interest rates low and thereby increased incentives for people to buy houses and companies to borrow money.
Getting rid of those trillions in extra assets — as the Fed expects to start doing later this year — is likely to have the opposite effect, blunting investment and dampening economic growth. And since the Fed has never done anything like this before, the real-world impact is hard to predict.
Wall Street’s reaction was muted, with no big moves among stocks or bonds. That suggests the Fed announcement more or less matched expectations.
Stock indexes were mixed, with the Dow Jones industrials gaining 0.2 percent to 21374.56 and the Standard & Poor’s 500 losing 0.1 percent to 2437.92. The yield on the 10-year Treasury note fell 0.08 percentage points to 2.126 percent.
Behind all the Fed’s big moves is a big, unanswered question: Why is the Fed so intent on tightening its policies and getting back to the old normal? Especially since it’s not clear the economy is ready.
True, the unemployment rate is nearing a 35-year low, usually a clear sign of economic strength. But just about every other major indication suggests there’s room for further economic improvement.
Among other things, wage growth is slow and falling. GDP increased at an anemic 1.2 percent in the first quarter. And the prospect of a stimulative tax-cut bill seems less certain than it did immediately after Trump’s election.
Then there’s inflation. It’s well below the Fed’s own 2 percent target, which should count as a reason for more stimulus, not less. Red-hot growth and low inflation rarely appear together.
But this isn’t how the Fed sees it. As policy makers put it in their official statement: “Near term risks to the economic outlook appear roughly balanced,” meaning they think the odds of overheating are just as high as the odds of a slowdown.
Time will tell, and it shouldn’t take all that much time. If the Fed is right, we should see rising inflation and growing wages even as quantitative easing gets undone and further rate increases take effect.
Otherwise, the Fed will face a choice. Let go of its commitment to normalization or risk triggering a new recession.Evan Horowitz digs through data to find information that illuminates the policy issues facing Massachusetts and the U.S. He can be reached at email@example.com. Follow him on Twitter @GlobeHorowitz