Paul Krugman thinks the Fed may have raised rates because the GOP got in its head

Paul Krugman never wanted the Federal Reserve to raise interest.

And yet on December 16, 2015, the Fed raised its benchmark rate for the first time in over nine years.

As for why the Fed went ahead and raised rates, Krugman posits in a blog post on Tuesday that perhaps the endless drumbeat of the apparent need to raise rates coming out of Wall Street and the Republican party may have gotten to the Fed in the end.

Said another way, the Fed’s harshest critics got in their head and forced action.

Here’s Krugman:

It really seems as if management somehow got set on the notion that it was time to raise rates — I think because, consciously or not, they wanted to throw Wall Street and the GOP a bone — and got into a loop of incestuous amplification in which the clear precautionary case against a hike got excluded from the room.

In the wake of this decision financial markets have been roiled as they adjust to a new policy regime from the Fed while continuing to work through the perceived feebleness of the US and European recoveries as well as a slowdown in the Chinese economy.

Krugman said that while this decision isn’t definitely a “policy error” — which is sort of the formal term for saying the Fed really messed up — he writes that, “surely everyone would be feeling more comfortable if the Fed had waited, and probably decided not to hike for a while.”

And we’d note, again, that in the months leading up the Fed’s widely-telegraphed decision to raise rates Krugman argued that the Fed’s dual mandate of full employment and price stability had not yet been achieved, therefore the Fed should not raise rates.

This is still the case, as the Fed’s preferred measure of inflation — “core” PCE — is running at around 1.4%, well below the Fed’s 2% target.

Elsewhere in his post, Krugman addresses the apparent slowdown in US economic activity and the disappointing outlook for inflation — particularly in the wake of the recent decline in oil prices.

Krugman dips a toe into another hot Fed debate — that of inflation expectations — making a passing reference to the Fed’s favoured market-based inflation expectations measure: the 5-year/5-year breakeven inflation rate.

In contrast to the alarm sounded by former Fed president Narayana Kocherlakota earlier this month in response to a decline in the 5-year/5-year — which measures expected inflation rates for 5 years ahead 5 years from now — Krugman says only that this rate “may not be a good indicator of expectations but surely contains some information” while noting that it has plunged. Which is true.

And while we don’t need to re-hash the full argument against using the 5-year/5-year as a real measure of real inflation expectations in the real economy, Krugman makes some progress in settling down the 5-year/5-year worrywarts.

Read his full post here »

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