To Raise Interest Rates Or To Leave Them Alone? The Federal Reserve Must Decide
ARI SHAPIRO, HOST:
To raise interest rates or leave them alone? That's the question before the Federal Reserve's Open Market Committee as it meets next week. Right now interest rates are under 2 percent. What the Fed decides can have big effects on the economy. But lately, it's gotten harder for the Fed to know exactly what those effects will be. Keith Romer from our Planet Money podcast reports.
KEITH ROMER, BYLINE: The big job of a central bank like the Federal Reserve is to keep the economy from growing too fast or too slow and keep inflation in check. Traditionally, the Fed would do this by changing interest rates. Set them high; inflation comes down. Set them low; inflation rises. Esther George is president of the Kansas City Federal Reserve Bank (ph).
ESTHER GEORGE: One of the common things that you look for as a central banker is price stability. So in other words, is inflation being affected by your monetary policy?
ROMER: And that's where the problem is. Interest rates have been really low, but inflation hasn't responded - and not just in the United States.
GEORGE: What we've noticed is, globally, the advanced central banks have been putting a lot of accommodation into their economy and yet not seen inflation rise.
ROMER: When changes in the interest rate stop affecting inflation, economists start to worry and look for explanations. One answer they've come up with - more and more industries are controlled by just a few very successful companies, obviously in tech but also in industries like banking, health care and airlines. This consolidation, they say, has three main effects.
First, a lot of these giant new companies have gotten so efficient that they have pushed prices down, which may be keeping inflation lower than anyone expected. A second way that big companies may be changing things is borrowing. It used to be that if a company wanted to expand, it needed to build new factories and buy new machinery, which would require a big loan. But modern companies depend less on physical capital and more on things like patents and software. John Van Reenen is an economist at MIT. He says that's true not just for tech companies like Google and Facebook.
JOHN VAN REENEN: Think about Walmarts in retail, a much more low-tech type of sector. But what Walmart's done is that it's invested huge amounts of money in building up better software.
ROMER: If companies don't need to rely so much on loans, changes in the interest rate will have a much smaller effect on whether or not they choose to expand. The final riddle these giant companies have created for central bankers involves the job market. Normally with unemployment as low as it's been, wages would rise. But they've barely budged. Some economists think this has to do with the decades-long decline in union membership. Others point out that when an industry contracts from 10 major companies to, say, three, workers will just lose some of their bargaining power.
VAN REENEN: What larger firms, in particular, can do is they can actually drive down wages below what the competitive level is.
ROMER: These giant companies are making it harder for central bankers to know how to think about interest rates. But Kansas City Fed President Esther George says not knowing for sure has always been part of the job.
GEORGE: I think we will never defeat uncertainty. And the question is - as we think about policy, are we factoring that in?
ROMER: Next week, when George votes on whether to move interest rates, she'll do so with a robust sense of what she does not know.
For NPR News, I'm Keith Romer.
(SOUNDBITE OF DJ MAKO'S "BLUE") Transcript provided by NPR, Copyright NPR.