Federal Open Meeting Committee - Photo by Federal Reserves

JAKARTA (TheInsiderStories) – United States’ Federal Reserve (The Fed) kept the target range of its federal funds rate (FFR) at 2.25 percent to 2.25 percent during its May meeting, noting that inflation is “running below” its stated target of 2 percent.

The Federal Open Meeting Committee (FOMC) also said that economic activity has been rising at a solid rate and that labor market remains strong and reaffirmed its position to be patient about further policy firming.

In a technical change, the Fed also reduced the interest it pays on excess reserves parked at the central bank as part of an effort to stop effective interest rates from breaking outside of its current target range.

The Fed’ decision not to change rates affirmed the March meeting’s economic projections signaling no rate changes for the rest of 2019. In that meeting, the Bank said low measures of inflation, concern over global growth, and tightening financial conditions warranted pausing on interest rate hikes while policymakers reassess the data.

The Fed held interest rates steady on Wednesday for the third time this year, ignoring calls from President Donald Trump to slash rates by as much as one full percentage point in order to further boost the economy.

“We have the potential to go up like a rocket if we did some lowering of rates, like one point,” tweeted Trump on Tuesday. “With our wonderfully low inflation, we could be setting major records.”

The last time the Fed cut its benchmark lending rate by one point was in December 2008, when the nation was in the grip of a financial crisis. Today, with GDP at 3.2 percent annual growth, unemployment at a near-historic low of 3.8 percent, and the stock market chalking up record highs, the economy is far from recession-era levels.

However, economic growth in the US is expected to slow this year as the wider global economy cools and the impact of Trump’s US$1.5 trillion fiscal stimulus plan begins to fade. A monthslong trade war between the US and China continues to weigh on global economic growth.

The central bank’s statement walked back its March view that the economy had “slowed” from the end of last 2018, noting that recent developments show that economic activity “rose at a solid rate.”

The Fed, however, said household spending and business fixed investment “slowed” in the first quarter. New numbers released Wednesday morning revealed the ISM manufacturing index dipping to a two-year low and construction spending falling amid lower home building.

Inflation remains the Fed’s most challenging puzzle, as strong GDP growth appears out of alignment with price increases. The most recent reading of personal consumption expenditures showed inflation of only 1.5 percent for March.

When stripping out energy and food prices — which the Fed has said is its preferred measure — “core” personal consumption expenditures grew 1.6 percent, raising an existential question of whether or not the Fed has lost its credibility in getting inflation to its 2.0 percent target.

In projections released in its last meeting in March, the median expectation for core PCE for 2019, 2020 and 2021 was 2.0 percent. On employment, the committee repeated its March language describing the labor market as “strong” with job gains remaining “solid.” An estimate-beating jobs report for March appeared to compensate for a weak February.

The decision not to raise rates was unanimously agreed upon by the members of the FOMC. The Fed also decided to tweak a key lever to its control over interest rates: interest on excess reserves.

As a method of controlling the money supply, the Fed incentivizes banks to park money at the central bank by paying interest on those reserves. The interest rate is within the bounds of the target set in its FOMC meetings and sets a standard for the interest rate that financial institutions ultimately use to lend out to consumers and businesses in the economy.

By design, when the Fed raises the interest it pays on reserves, it incentivizes banks to leave more money in reserves at the Fed, thus contracting the money supply and notching up the effective interest rates in the market.

In reverse, when the Fed lowered the interest it pays on reserves, it incentivizes banks to leave less money at the Fed, thus expanding the money supply and lowering the effective interest rates in the market. As of the March meeting, the Fed was paying 2.4 percent on interest on excess reserves.

Written by Lexy Nantu, Email: lexy@theinsiderstories.com