– November 13, 2015

Monetary Policy
Conflicting forces beset Fed policy makers as their December meeting nears

The Federal Open Market Committee left interest rates unchanged at its October meeting. But in its post-meeting statement the committee explicitly said that a December rate liftoff was under consideration. This signaled to financial markets a likely December liftoff.

However, data released before the Fed’s October meeting suggested that the economy was cooling. That led to concerns that a rate increase could significantly damage growth, and it built pressure to keep short-term rates near zero longer or even to push them into negative territory.

One reason to raise rates would be market expectations. These stem from the public statements of Fed officials, which earlier made an implicit commitment to begin raising rates by the end of 2015 and most recently pointed to the December meeting. Failing to deliver may undermine the credibility of the central bank. To the Fed, credibility is particularly important now. This provides an incentive to act before the year-end, to prove it can reach its goals.

Another reason for raising rates next month is the longstanding link between unemployment and inflation. The jobless rate now stands at 5 percent, which is considered nearly full employment. Normally, such a low level of unemployment would risk heating up inflation. The Fed may believe that increasing interest rates is necessary to curb this risk. But inflation has been well below the Fed’s 2 percent target for almost three years. Policy makers must consider the possibility that the relationship between unemployment and inflation will not hold in the future.

At the same time, economic data has been mixed, with signals of weakness (stagnant wages, slowing GDP growth in the third quarter, a faltering global economy, and a stronger U.S. dollar) contrasting with the latest strong jobs report and details of the GDP report that showed strength. This makes the decision more difficult.

If the Fed does boost rates in December, it will likely take a small step, such as a quarter of 1 percent, or a 25-basis-point move, and further increases will be slow in coming. This is the message from Fed officials’ public statements. A slight rise in short-term rates is unlikely to have a big impact on businesses and consumers. To avoid a ripple effect, investors should not overreact to a rate move. Standing pat may be the best reaction.

Fiscal Policy
Congress staves off budget and debt crises, but long-term challenges remain

In late October, Congress approved the Bipartisan Budget Act of 2015, which resolved two pressing issues when President Barack Obama signed it a few days later.

First, the measure suspends the government’s debt ceiling through March 2017, letting the government borrow as much as it needs before then. Passage came just in time, since the Treasury Department said that the debt ceiling would have been exceeded on Nov. 3. The legislation also authorizes federal spending for the next two years, providing targets for new appropriations bills that still must be enacted before Dec. 12 to maintain government funding for the current fiscal year, which began Oct. 1.

Other provisions of the act have a more direct impact on people. One shifts some Social Security tax revenue to the Social Security Disability Insurance Trust Fund, extending the life of that program by several years. Without this change, money would have run out within a year.

Another provision limits a substantial increase in some 2016 premiums for Medicare Part B health insurance, which covers physicians’ services for people 65 and over. Because prices actually declined in 2015 (inflation was negative) and no cost-of-living adjustment to Social Security is scheduled for the 2016 calendar year, about 70 percent of those on Medicare will see no change in Part B premiums. But to cover the rising costs, the other 30 percent, including those who are not receiving Social Security and those who sign up for Medicare for the first time in 2016, would have seen their premiums rise by more than 50 percent. In July, the Medicare Trustees Annual Report estimated the monthly charge would jump to $159.30 from $104.90 currently.

The Bipartisan Budget Act limits the rise to about 19 percent, setting the premiums at $120 a month. But the story does not end there.

Because of the change under the budget act, total premiums will fall short of covering a quarter of Part B costs, a level that is set by law. To close that gap, the Treasury Department will lend money to Medicare. To repay the loan, those who benefitted from the reduction in the premium increase will pay a $3-per-month surcharge for as long as it takes to repay the debt.

The budget act resolves several immediate budget issues – funding the government for the current and next fiscal years, saving the Social Security disability program from an imminent collapse, and limiting Medicare Part B premium increases. But it does little to meet longer-term challenges posed by entitlement programs. Medicare costs are rising. Social Security outlays will continue to exceed payroll tax revenue. This imbalance will have to be addressed sooner or later. So while the budget measure settles some fiscal policy fights for the next couple of years, a larger budget battle may ensue.

Next/Previous Section:
1.Overview

2. Economy

3. Inflation

4. Policy

5. Investing

6. Pulling It All Together/Appendix

AIER Staff

Founded in 1933, The American Institute for Economic Research (AIER) educates people on the value of personal freedom, free enterprise, property rights, limited government, and sound money. AIER’s ongoing scientific research demonstrates the importance of these principles in advancing peace, prosperity, and human progress.

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