Moving Targets

Our central bank is charged with a dual mandate.  In short, they are trying to steer the economy toward two seemingly opposing goals: full-employment and steady inflation.  When trying to focus on bolstering employment, the Federal Reserve tends to keep interest rates low which encourages borrowing, thus boosting output and, ultimately, jobs.  Alternatively, during periods of higher than desired inflation, central bankers increase rates, attempting to minimize upward price pressures by slowing borrowing demands which frequently slows output and employment growth.  Sounds simple enough, right?

Central bankers face a problem: moving targets.  For instance, nobody ever knows for sure the economy’s full-employment rate.  Our economy’s tolerance for high levels of employment changes all the time.  It is sort of like humidity that way; meteorologists report humidity in terms of percentages of capacity.  Air holds more water when it is warmer, so even if there is a larger quantity of moisture in the summer atmosphere, rain is less likely to fall.  Likewise, business cycles have varying capacities for employment before heating up inflationary periods begin reigning.  With unemployment at generational lows, it appears our economy’s tolerance for employment levels is greater than in recent past cycles since wage pressures remain subdued.

Like meteorologists, central bankers concern themselves with sequence.  Weather professionals call them seasons, while economists refer to business cycles.  Despite the low levels of inflation, the Federal Reserve prepares itself for the next economic winter.  They are now in the middle of raising overnight interest rates, which they believe are lower than necessary given the strength of our economy.  This effort will continue next week, and Atlas expects at least one more hike before this year ends and possibly even a few more tightening measures next year.  Each subsequent hike will make the Fed’s work harder because they are swaying the economy’s capacity for both inflation and employment.  Imagine future weather being influenced by your favorite weather person’s forecast.  Okay, stop that, that thought experiment might go on forever.