A badly mismanaged U.S. economy is now going through a cyclical adjustment marked by an extremely expansionary fiscal policy, price rigidities and trade flows in a world split along increasingly bellicose security fault lines.

That is the general setting in which the policy making committee of the American central bank (the Fed) has to make decisions about interest rates.

A particular difficulty at this point of an election year is that nobody knows what kind of fiscal policy will be in place when the Fed’s current interest rates begin to hit private consumption, housing demand and business investments three to four quarters from now.

That’s the time horizon for the new administration to become fully operational and to be able to get its fiscal policy approved by the U.S. Congress.

All that is not an advocacy for the Fed to do nothing; it’s just a reminder that the Fed’s task is quite difficult because it works with a policy instrument – the quantity of money -- that operates with long and variable lags.

To properly calibrate its policy, the Fed needs to know where exactly the economy is at the point when decisions are being taken. And, more importantly, the Fed has to know where the economy will be when those interest rate changes begin to affect economic activity.

No room to cut interest rates

If that sounds like the Fed is flying blind, you get a typical monetarist exaggeration. Perhaps closer to the truth is the idea that the Fed’s visual navigation is struggling to land through the most hazardous low flying clouds.

Indeed, surveys of business conditions, information on product and labor markets and foreign trade transactions are available. The Fed, therefore, is not completely flying blind. But the complexity of the data, its timeliness and quality, make extrapolations of past trends a poor substitute for highly probable forecasts the Fed really needs.

Here is an example: A simple fact that the U.S. economy grew in the first half of this year at an annual rate of 3% would now categorically rule out any monetary easing.

Indeed, at that pace of advance, the economy is moving along way above the physical limits to its potential and noninflationary growth estimated at 1.6% -- based on the sum of productivity and labor force growth.

On that evidence, one can even go further to conclude that the Fed’s current policy setting is quite accommodative – a manifestly inappropriate policy choice at a time when the actual growth far exceeds the economy’s noninflationary potential.

That conclusion is backed up by empirical research that would consider the Fed’s current real policy interest rate of 2% as a neutral policy stance. That’s the number you get when you subtract the annual change of the core consumer price index of 3.3% in June from the Fed’s latest effective federal funds rate of 5.33%.

With inflation above its medium-term target of 2%, and the economic growth far exceeding its physical limits to sustainable growth, the Fed’s policy interest rate should be considerably higher than its present level of 5.33%.

Neutral policy in an election year

The latest surveys of business conditions also indicate that interest rate cuts demanded by the financial community are not appropriate – and could even be detrimental to Fed’s efforts to “normalize” the monetary policy distorted by decades of “quantitative easing.”

The Fed’s Beige Book (a publication that provides a summary of current economic conditions in 12 Federal Reserve Districts) issued last month reports growing activity in most areas, with increasing wages and prices.

Much more detailed monthly surveys are also published by the Institute of Supply Management (ISM). Earlier this month, the ISM report covering the manufacturing sector (about 10% of the U.S. economy) reflects structural problems in the goods producing industries – a legacy issue created by the wholesale offshoring in search of lower labor costs.

By contrast, the ISM service sector report (covering 90% of U.S. economy) showed strong increases in July of business activity, new orders, order backlogs, employment and faster price increases for 86 consecutive months.

All that survey data clearly suggest that a 3% GDP increase during the first half of this year continued unabated. And, surprisingly, a 2% increase in exports over the same period also showed that there was a sustained external demand for U.S. goods and services – despite growing geopolitical tensions and economic stagnation in the European Union that takes 25% of American foreign sales.

Wall Street jitters earlier this week marked its worst trading day in nearly two years -- but the Fed had no reason to oblige.