Federal Reserve policy makers are in a tough spot. If they raise rates at their meeting this week, they know they could stir trouble. But if they don't, they risk forestalling a day of reckoning they believe must come.
One way out: overhaul the framework they have put forward for setting policy.
A month ago, the Fed was on course to tighten policy this week, but financial-market turmoil has altered that call. Where in August 82% of economists surveyed by The Wall Street Journal expected the Fed to raise its target range on rates at its two-day meeting ending Thursday, that number was cut to 46% in this month's poll.
The divided response from economists is reflective of a Fed that itself is divided. Some members of the central bank's rate-setting committee would like to delay a rate increase until next year. That isn't just because of the financial-market environment. It also is because the interrelated effects of a stronger dollar, lower commodity prices and economic weakness overseas look to further chill inflation.
In June, Fed policy makers' projections centered on an expectation that consumer-price inflation excluding food and energy would be just 1.3% to 1.4% in the fourth quarter from a year earlier. Incoming data suggest they should take that estimate even lower when they update projections this week.
But policy makers also need to raise their projections for economic growth. In June, these centered on an expectation that fourth-quarter gross domestic product would be up 1.8% to 2% on the year, while economists' current estimates put growth at about 2.4%. Their unemployment rate projections centered on a fourth-quarter average of 5.2% to 5.3%. Last month, the unemployment rate fell to 5.1%.
The steady economy and strengthening job market is one reason some at the Fed would prefer to raise rates now, and they view unsettled financial markets as a poor excuse for not acting. More generally, Fed officials may worry that not moving on rates, but saying that a rate increase is really, really close, may only serve to keep markets unsettled.
In seeking to corral these competing views, Fed Chairwoman Janet Yellen could craft a consensus in the following way: Get it over with and raise rates by a quarter point. But within its postmeeting statement commit to hold off on further increases until inflation is picking up, and underscore that with a move lower in interest-rate projections for the end of next year. In June, these centered on a range of 1.5% to 1.75%.
Such a move would help limit any bad response by markets. And given the backdrop of ultralow inflation, it would probably reflect where policy is heading anyhow.
Write to Justin Lahart at justin.lahart@wsj.com
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