Following better-than-expected job growth in November, the Federal Reserve on Dec. 13 voted to raise the federal funds interest rate by a quarter of a percentage point.
The Fed also plans to raise rates three more times in 2018, according to most analysts.
Kurt Rankin is vice president and economist for The PNC Financial Services Group based in Pittsburgh, which also monitors economic growth in the West Michigan market.
He said the Fed’s decision to raise its key short-term interest rate range to 1.25 percent to 1.5 percent follows the U.S. Bureau of Labor Statistics’ November report, which showed total U.S. employment rose by 228,000 in November, above the consensus of 199,000, and the unemployment rate held steady at 4.1 percent — the lowest rate since late 2000.
Rankin said the November report is confirmation the U.S. economy remains in solid shape at the end of 2017, and the Fed’s decision to raise rates is a vote of confidence in continued growth in 2018.
“Monetary policy is managed by the Federal Reserve as a way of managing the pace of growth. Loose monetary policy with low interest rates, in theory, could incentivize businesses to borrow and expand,” he said.
“The historically low rate, at zero percent, was essentially taking monetary risk out of the equation. They were incentivizing businesses to borrow by setting interest rates as low as they could go. … Given businesses did not take advantage of the zero percent (federal funds rate) for the time coming out of the recession, rising to 1.25 percent to 1.5 percent will not be the deterrent economic theory would suggest.”
He said the theory under which the Fed is operating is that normalizing to a long-term rate of 2.5 percent will stabilize inflation to 2 percent, sustain a healthy job market and encourage businesses looking to expand.
“It is the interest rate at which businesses will react. If it’s any lower, they won’t react, and if it’s any higher, they won’t,” he said.
Rankin said if the Fed had chosen not to raise rates, investors might have taken it as a sign the economy is losing steam.
“(Not raising the interest rate) would send a signal to financial markets that could be interpreted in several ways,” he said. “One would be the Fed sees something slower in that data than it would like to see and is holding off on tightening/normalizing monetary policy. It might be weaker inflation or weaker than expected job growth. The goal is maximizing employment in the context of stable inflation, which is deemed to be 2 percent.”
One weak spot in the November report was wages. They rose just 0.2 percent in November and were up 2.5 percent over the previous year, a disappointment in light of the fact the economic expansion is more than eight years old and unemployment low, Rankin said.
The same holds true in West Michigan, he added.
“It’s going to be difficult for a small market like Grand Rapids to continue growth without wages growing rapidly,” he said. “We are seeing wage growth — wage growth in Grand Rapids is up around 3 percent year over year, but up until the past couple months, it was at 1 percent or even flat.
“The labor force does continue to expand in Grand Rapids, but at a far slower pace than 2015 and 2016. These are signals that with national job growth high, there is more competition for workers. Grand Rapids is not unique in their need to attract workers from outside the region.”
He said any business expansion spurred by the Fed’s actions would need to be supported by wage growth to meet talent demands.