Will Fed Dare Raise Interest Rates?
However, more interesting than the question of whether they should do it is the question of whether they are likely to do it. Central bank action tends to be relatively unpredictable, compared to the effects of central bank actions once implemented, but I will still speculate about it.
It seems clear that some Fed officials, most notably Philadelphia Fed chief Charles Plosser wants to raise interest rates, as they correctly identify the very strong inflationary pressures. And while most other Fed officials are a lot less hawkish than Plosser, most recognize that inflation is indeed a big problem.
However, just because they view price inflation as a problem doesn't necessarily mean that they'll actually do something about it. The reason for that is first of all that the economy will likely continue to contract, especially after the temporary boost from the so-called tax rebates is removed. And with growth negative and unemployment rising, raising interest rates will create very negative political reactions, especially in the emerging Democratic supermajority.
The second reason is that raising interest rates would likely again flatten the yield curve, which in turn would hurt the many weak financial institutions. Of course, a quarter point hike wouldn't do much difference in that respect, but then again a quarter point hike wouldn't do much difference in terms of containing inflation either.
The only way the Fed could rein in inflation in a meaningful way would be to do another Volcker and raise interest rates so high that the economy falls into a very deep downturn. This downturn would likely be even greater than in 1981-82 because the level of debt is much higher and the financial institutions much more fragile. Faced with the choice of higher inflation and long term decline on the one hand and a painful short term purge of inflationary excesses on the one hand, the Fed seems more likely to choose the former.
It is still possible, but very far from certain, that the Fed might raise a quarter point or two later this year. However, even if they do, such modest moves from the current ultra-loose stance will not prevent inflation from getting worse.
UPDATE: Bob Novak, known for his Washington D.C. connections says the Fed will likely not raise interest rates.