The Fed raised rates into an economy it calls solid

What changed

On the afternoon of September 16 the Federal Open Market Committee raised the target range it sets for the rate banks charge each other overnight. The Committee had held that range at 3-1/2 to 3-3/4 percent at both its June and July meetings. It is now 3-3/4 to 4 percent, and it took effect the following morning. The Federal Reserve's own explanation of this tool gives two reasons for raising rates: an economy that is overheating, or inflation that is too high. The Committee pointed at the second one. Its statement calls economic activity solid and domestic spending resilient.

Three of the Committee's own members had wanted this in July. The July statement was approved 9 to 3, and Beth M. Hammack, Neel Kashkari and Lorie K. Logan voted against holding the range. The statement records that all three preferred to raise it by a quarter point at that meeting, which is the move the Committee made seven weeks later. The September statement carries no dissent, and Warsh described the Committee's vote on the decision as unanimous.

Three separate moves happened at once. The Federal Open Market Committee sets the target range for the federal funds rate. The Fed describes that as an interest rate for overnight borrowing by banks. The Board of Governors, which runs the Federal Reserve, then set two rates of its own. Banks now earn 3.90 percent on money they keep at the Fed. They pay 4.0 percent to borrow from it. The Committee also directed a trading desk at the Federal Reserve Bank of New York, one of the Fed's regional banks, to run the daily operations that hold the rate inside the range.

The Chairman, Kevin Warsh, set the test in public nineteen days before applying it. At the Jackson Hole symposium in Wyoming on August 28, Warsh named a standard. "We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed." The same speech drew the line plainly. "I stand here today committed to a discipline, not to a decision." On September 16 Warsh said the Committee had decided that this standard was not satisfied.

Why it matters

The Federal Reserve's own explanation is plain about what follows. A change in the federal funds rate normally affects, and is accompanied by, changes in other interest rates and in financial conditions more broadly. Those changes then affect the spending decisions of households and businesses. Two words there carry the weight. Normally, because the Fed is stating an expectation rather than a guarantee. And other, because the rate the Committee moved is the one banks charge each other overnight. The rates a household pays or earns are among the other ones that are meant to follow.

The inflation the Committee is aiming at has run above its 2 percent goal for more than five years, by the Chairman's account. Warsh said the most recent consumer and producer price data put the twelve-month change in total personal consumption prices at likely around 3.6 percent in August. Core personal consumption prices are running at about 3.2 percent and consumer prices at about 2.4 percent. Too many categories, Warsh said, are still posting increases above 3 percent on both a six-month and a twelve-month basis. The prices of many key commodity inputs rose over the period between meetings.

The other half of the Fed's job looks healthy by its own measure. Warsh called the labor side of the Fed's congressional remit in good shape. The jobless rate is low at around 4.1 percent, job openings and weekly hours are increasing, and unemployment claims are running at levels consistent with full employment. That figure, 4.1 percent, turns up twice in this story for two unrelated things. One is the share of people looking for work. The other is where the Committee's median projection puts the interest rate at the end of this year. They are different measures that happen to land on the same number.

What to watch

The Summary of Economic Projections came out the same afternoon. That is where the next move is written down. Its median puts the appropriate federal funds rate at 4.1 percent at the end of this year. It has the rate staying there through next year. The middle of the range the Committee just set is 3.875 percent. So the Committee's own middle view is one more step the size of the one it just took, then a stop.

The same projections expect total personal consumption inflation of 3.7 percent this year. They have it falling to 2.3 percent next year. The rate, meanwhile, sits still. Those two lines are the pair to watch together. The Committee is looking for inflation to fall 1.4 percentage points without tightening much further. It says inflation risks are to the upside while labor risks are roughly balanced.

The discovery worth keeping came from the Chairman. Warsh read out the Committee's projections and then stepped outside them. The Summary reflects the views of colleagues on the Committee, Warsh said, adding: "I have not offered a projection of my own." That has now happened twice, in June and again in September. So the median pointing to one more step is a forecast from everyone on the Committee except the Chairman who read it out.