Inflation Is Higher Than You Think so Fed Should Raise Rates Now

October 19, 2015 Updated: October 20, 2015

The Federal Reserve should raise interest rates because inflationary pressures are greater than most policymakers admit and the economy is nearing full employment.

Seniors won’t get a boost in their Social Security checks this year because consumer prices for urban wage earners—the measure the government uses to adjust those payments—fell from the third quarter of 2014 to 2015. However, that’s largely because oil fell from over $100 a barrel to less than $50, pulling down retail prices for gasoline, home heating oil, and related commodities.

Remove energy prices and the broader, the all urban Consumer Price Index commonly used to measure inflation is up nearly 1.9 percent. As domestic oil and natural gas production fall, energy prices will rebound. That will push up costs for airlines, supermarkets, and many other businesses that must be passed on to consumers.

With the economy nearing full employment, easy money could set off a wage-price spiral reminiscent of 1970s double digit inflation.

An increase of just $10 a barrel would likely boost any measure of inflation government number crunchers could devise above the Fed’s 2 percent target for price stability. Even with turmoil in China and retrenchment in the oil sector, U.S. GDP growth is expected to exceed 2.5 percent. That’s significantly better than the first six years of the recovery, because consumer spending, which accounts for nearly 70 percent of the economy, is advancing at about a 3.5 percent annual pace.

Household balance sheets are in great shape, thanks in part to the recovery in housing and stock prices and a sustained period of consumer led growth seems likely. That will boost tax revenues and federal and state government spending, and further accelerate growth.

Job openings are near their highest level since the recovery began but hiring has slipped a bit, because employers can’t find workers with the right skills, and wages are likely to rise more rapidly. For example, Wal-Mart’s plan to pay workers more is shifting more of the retail behemoth’s profits to its employees.

Higher wages will not inspire most of the 7 million men between the ages of 25 and 54 who are too old for college, too young to retire, and not looking for working to seek gainful employment. They have become accustomed to collecting expanded government benefits, sponging off relatives and girlfriends, and spending their days watching NFL highlights on ESPN.

Keeping interest rates near zero, as the Fed has done since 2008, will do little to fix the shortage of job applicants with skills businesses are seeking, or inspire indolent adult males to lead productive lives. However, with the economy nearing full employment, easy money could set off a wage-price spiral reminiscent of 1970s double digit inflation.

Low interest rates impose other costs and distortions on the economy. For example, those penalize seniors who depend on certificates of deposits to supplement stagnant Social Security and pension checks, and force the elderly to seek part-time employment.

Low interest rates also push up land values-especially for choice real estate in hot markets like New York and California to levels that discourage urban redevelopment. Low rates discourage banks from providing longer term financing to new businesses, but low rates provide cheap capital for Wall Street traders, private equity, and activist investors who buy companies, strip assets, and flip investments quickly. The latter is attracting some of the best young business school talent to those nonproductive pursuits.

Higher U.S. interest rates will make servicing debt tougher for developing country governments and businesses, especially those who have borrowed in dollars. However, foreign central bankers have warned the Fed that perpetual hesitation about raising rates contributes to uncertainty and are urging Chair Janet Yellen to simply pull the trigger now.

Keeping interest rates near zero served a purpose when the economy was struggling in the wake of the financial crisis, but now those now actually harming the economy and could set off unwanted inflation. That’s why it’s high time for Yellen and the Fed to stop pixilating and raise rates.

Peter Morici, professor at the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. Previously he served as director of the Office of Economics at the U.S. International Trade Commission. Follow him on Twitter @pmorici1

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Peter Morici