According to reports, minutes of the meeting of US Federal Reserve show that members of the Federal Reserve want US interest rates to be raised to 2.4%. This rate is currently perceived to be the neutral rate of interest for the US economy.
Neutral rate of interest is the rate of interest that neither gives a boost to the economy nor slows it down. This means that US Federal Reserve members are at present more concerned about controlling inflation rather than about stimulating growth. They are willing to move to an interest rate level that does not encourage growth but can control inflation in the short term. Interest rate above the neutral level will start having a negative impact on economy; it will start reducing the rate of economic growth.
Many are drawing comfort from this report. They are interpreting it as the sign that US central bank will not opt for recession for controlling inflation. Recession means when the economy starts contracting. Contraction means negative GDP growth. Two consecutive quarters of negative GDP growth is classified as a recession.
But these minutes of meeting actually do not bring out any surprise or cause of hope. When a central bank tries to stabilize a rising rate of inflation it tries to take the interest rate to the neutral level. At the neutral level actual output or GDP of the economy becomes equal to its potential GDP and inflation rate stabilizes. Central banks follow the Taylor’s rule here. This rule is that for every 1% rise in inflation rate above the target inflation rate of the central bank, interest rate is raised by 0.5% point. Target inflation rate of US Federal Reserve is around 2%.
