The full employment and a strong US economy are not the reasons of rate hike alone, but only if they coincide with the inflation and inflation expectations, nonetheless it is true that the Fed is tightening in the hindsight of inflation and expectations when the economy reached closer to the full employment and a strong economy gave it back up for rate hikes to act during the next crisis by normalizing the interest rates without slowing the economy when it set an inflation target of 2% which has been consistently near the target after undershooting for years eventhough the unemployment reached 5% a figure said to be close to full employment.
Nonetheless, prices or inflation and inflation expectation have failed to materialize to a considerable extent except the stock market which has been close to life time high amid the debate that too much higher short run rates or inverted yield curve when the gap between 2-years bonds and 10-years bonds increases against the fundamental that long run rates are higher than the short run rates which might lower demand for investment and increase selling stocks and bonds and deleveraging and defaults due to too much higher rates which is right for both the US and the emerging economies.
This has happened many times in the past when the yield curve inverted which had led to recessions, the Fed is trying to avoid this this time, but it is really a big question that it would succeed since it has missed it many times before that met slowdown in the past business cycles, the economy eventually hit recessions everytime before when short run interest rates exceeded the long run rates, however the economists knew about neutral real interest rate that neither boosts nor contracts the economy, but failed to follow.
The point that was probably missed during the past recessions that higher borrowing cost could further increase inflation by reducing supply if the economy is at full employment and lower investment which increases or magnifies the lower supply and inflation cycle, the Fed failed to notice that higher unemployment and lower investment would also increase inflation and would not let supply side mechanism work which increases supply with higher prices.
Nonetheless, had the Fed used the neutral rates around full employment it had better managed demand and supply and inflation and growth of the economy because lower interest rate also increase productivity of capital which might lower the price level and inflation that may increase investment and allocation of labour to the sector which have been overheating, stable interest rate could further increase trade and imports which might also reduce the price level...
Moreover, the Fed might claim that full employment increased rate hikes and slowdown which should had been be dealt with stable interest rates rather than rate increases that would help contain unemployment and production and demand and supply and prices.
Higher interest rates would also lower supply and increase the price level.
The neutral rate is nothing cast in the stone and might vary with supply side measure or prices or inflation and structural changes in the economy; a higher inflation could increase the neutral real rate of interest rate and a lower inflation could lower the neutral rate.
Similarly, full employment could also vary within a range depending on the rate of population growth and workforce and wages, higher wages could also increase labour force participation and lower unemployment or increase the full employment rate.
Stable interest rate and prices near full employment could be crucial to balance the economy, however deviations apart from full employment are self-fulfilling in nature, a lower interest rate would lower the price level and a higher interest rates could increase the price level depending on the level of unemployment or full employment, if the economy is below full employment a lower interest rate would lower the price level by increasing investment and employment and supply and a higher interest rate would lower employment and supply and increase the price level.
Notwithstanding, only if the economy is at full employment a lower interest rate would increase inflation because demand would go up and supply cannot be increased and a higher rate would lower demand and inflation or prices which would reduce supply.
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