In what will be one of Janet Yellen's final moves as chair of the U.S. Federal Reserve, interest rates will likely be raised before the end of 2017. This introduces the possibility of further rate hikes in 2018, as the outlook for the U.S. economy looks increasingly rosy due to strong job growth and building excitement over likely tax cuts.
"The reality is the economy is doing very well," said Tim Duy, a Fed expert, citing active financial markets and Trump's pending tax reform. Elevated asset values, including booming stock prices, are also a contributing factor. The Federal Reserve Bank of Chicago's index of financial conditions shows that they are nearly the loosest level since the mid-90s.
It is expected that the rate will be raised by one quarter of a percentage point on December 13, 2017, shortly after the Fed's final policy meeting of the year. This hike will be the fifth since the financial crisis of 2008 - 2009. The Fed predicted in September that it will make further hikes three times in 2018 and twice more in 2019, but these predictions were made before the November jobs report and the introduction of Trump's tax reform, both of which augur a strong economy with little unemployment and robust growth. Analysts expect that this unexpectedly good performance may cause the Fed to add at least one more hike per year.
Since her appointment in 2013, Yellen has generally taken a slow, patient approach to stimulating the U.S. economy post-crisis. The Fed has held interest rates low to encourage investors to take risks, and to coax investors and businesses into borrowing money. The Fed must strike a balance to keep growth sustainable. It does not want the economy to grow so quickly that inflation bubbles to more than 2% a year, but it also does not want to stifle growth.
Although the economy has thus far exceeded expectations in terms of growth, it is difficult to determine whether this trend will continue in 2018. Despite all the positive signs, including low unemployment, a decline in loan rates, and a loosening of credit terms, potential sources of concern remain. Wages have not risen as much as might be expected from the overall strength of the economy, and inflation has lagged behind, up only 1.6% from October 2016. Some think that the Fed should continue to be patient, and not rush to raise rates.
The likely tax cut complicates matters. Monetary policy tends to influence economic performance gradually, so the Fed must try to evaluate what this influence is likely to be. Proponents of the tax cut have argued that it will spur growth in both the short and long term, but others, including Fed officials, are skeptical, as the cuts will drive up the federal debt and, by extension, interest rates.
And Republicans behind the tax cut want their constituents to experience its immediate benefits so as to retain their popularity, and do not want such benefits to be offset by rate hikes. Thus going forward the Fed may face political pressure on its decisions, too.