With inflation being a lagging indicator, it is often too late to rein it in once it has appeared. Central bankers need to head it off before it starts coming through in a meaningful way.
They of course know this, which begs the question, why is the Fed so reticent to add as much as a quarter point to the rate despite a relatively robust US economy?
In fact, the FOMC itself is not sure it is on the right path, as evidenced by three of the members breaking ranks and voting for a raise at the latest meeting.
The mantra often repeated is ‘we will watch the data’. That sounds a sensible and obvious thing at first, but scratching just a little beneath the surface reveals how little that statement really tells us.
Different parts of the economic data picture suggest different things about the US economy and the prospects for inflation. Not only that, the same data points even change month to month at the moment.
Sub 5% unemployment suggests inflation is just around the corner and that the Fed should make a move, but as an FOMC meeting nears non-farm payroll figures undershoot forecasts and make the committee nervous about a raise. One month PMI’s come through stronger than expected and the next they show signs of a retraction in either manufacturing or services activity.
Growth projections for US GDP also fluctuate, but by most accounts are healthy at around 3%.
If the FOMC does not have a real masterplan and is purely ‘watching the data’ it stands to get blown one way then the other like a boat in a storm.
The latest damp squib of a meeting is particularly risky in terms of the Fed losing its way because of the election on 8 November. Its understandably strong disinclination to act a few days before a Presidential election means the central bank effectively has to sit on its hands until December now. That amount of time could easily allow inflationary pressures to get out of hand, particularly if there is significant oil price appreciation.