Dear Federal Reserve: stop waiting for the 'perfect' time to raise rates and just do it
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Version 0 of 1. To raise, or not to raise? (Interest rates, that is.) Related: Markets brace for US Federal Reserve interest rate decision - live updates That’s the question that Federal Reserve policymakers were grappling with on Thursday – and economists betting on the outcome were pretty evenly divided. That was probably because world events once again made the Fed’s decision a far, far less simple and straightforward matter than its chairman, Janet Yellen, clearly hoped it would be when she began sending out signals that September would mark the turning point. For context, the last time the Fed raised rates, in 2006, no one would have tweeted their decision – there was no Twitter. For that matter, smartphones were still nearly a year away. The Fed’s decision to keep lending rates at nearly zero for almost seven years, in the aftermath of the financial crisis and the recession that followed, did the job: it helped save the US economy from collapse. Providing the financial system with virtually free money may not have been enough to restore the economy to its pre-crisis vigor, or save homes from foreclosure, or help all those who lost their jobs find new employment on the same terms. But there is a limit to what we can expect monetary policy, on its own, to accomplish. In the tense environment leading up to Thursday’s meeting, an odd assortment of critics ranging from former treasury secretary Larry Summers to progressive nonprofit groups argued that this was precisely the wrong time to start making it more expensive to borrow money. China’s economic turmoil, which has sparked a vast stock market selloff and risks creating a crisis of confidence in that country’s government – a much more serious issue – has had ripple effects around the world, triggering tremendous volatility in the US market. Commodity prices have fallen sharply this year too: even the prices of the riskier kinds of bonds have been hit. These events could have given Fed policymakers a very welcome excuse to hit the “pause” button yet again, postponing a rate hike decision until at least their December meeting with the twin arguments that it is too risky to forge ahead in the uncertain market environment and that, anyway, emerging market turmoil has managed to take any steam or froth out of the US economy, reducing the danger it will overheat. Once again, the Fed could have a good set of events to point to and argue that it’s still wiser to “wait and see”. But the truth may be that there’s no such thing as the perfect time for the Fed to act, but that the more policymakers stall, the more other, less evident dangers will become more significant. At some point the Fed must step in and raise rates – unless it chooses to simply abdicate this role altogether – and delaying the inevitable may actually create more risk than taking that first small step. Consider what it is that we’re talking about: an increase of 0.25% in the target rate of the Federal Funds rate, which currently is set in a range of zero to 0.25% – a level that at the time it was set was unprecedented in the central bank’s history. While the US economy is not in full growth mode, its pace is a respectable 2.2% or so and seems to be stable. Unemployment has been cut in half from the levels recorded back in 2008. So if the Fed keeps interest rates at their crisis levels, what message will Yellen and co be sending to the public: that they have access to some kind of information that suggests the US economy is in worse shape that we are aware and thus more vulnerable to a rate hike, which they won’t reveal? Or that they fear the changes that have followed as a result of this prolonged near-zero rate policy will make it impossible for them to manage the rate hikes as smoothly and gracefully as in days of yore? In Yellen’s shoes, I wouldn’t want to be sending either of those messages – especially when the central bank increasingly has been the target of muttering about a “credibility gap”. Let them mutter, you say? Well, that’s fine, until there’s a run on the dollar and on dollar-denominated assets like stocks and bonds because global investors lose confidence in the Fed. Right now, the US is benefiting from being one of the strongest players in a still-weak global economy, but that won’t always be the case and one of the factors that has kept the US in that position is the Fed’s leadership. Of course, if a quarter-point rate hike would have a significant impact on the economy (and if that economy were fragile), this would be a very different discussion. But the impact is most likely to be psychological: the reversal – however well-telegraphed, infinitesimal and carefully orchestrated – of a policy that has been unchanged for seven years, taking place in a period of global economic uncertainty, is going to be jarring. So too, however, is leaving rates unchanged. Would the market volatility of the past several weeks have been as pronounced had the Fed already embarked on its rate-hike program, and put that source of uncertainty behind the market? I don’t think so. Not knowing what the Fed will do and when it will do it – one of the very, very few factors that does lie within the control of policymakers – has been a source of unease and uncertainty for years. For proof, you just have to go back and take a look at the anxiety and volatility that has surrounded every Fed meeting and the release of every set of minutes from those meetings, anxiously scanned by economists, traders and investors looking for the minutest clues to the thinking of Yellen and her colleagues. That kind of Kremlinology is nothing new – once upon a time, when Alan Greenspan was spotted sneezing in the morning, rumors he had died would be rippling through trading desks by mid-afternoon, sending the bond market into a tailspin. But it’s easy to put an end to such rumours with a single, small rate hike – and that move has some benefits, too. Firstly, it puts an end to all the longstanding speculation and uncertainty, and tells doubters that the Fed is taking control of the process. Secondly, it’s a step back toward normalization – or at least, toward a new normal, whatever that ends up looking like. Thirdly, to the extent that market forces haven’t done enough to shock us into awareness that there’s a potentially nasty credit bubble lurking out there, the Fed can at least try to address it, rather than leaving it to its own devices. (By now, we should all know what havoc bubbles, left unattended, can wreak on financial markets and economies.) Ultimately, however, a small rate hike will give Yellen and her colleagues a bit of flexibility down the road. It removes the immediate pressure about whether to act (although if the global economic situation doesn’t worsen in the coming months, the odds increase that we would see another rate hike by March). And if things do turn suddenly very sour, well, once again the Fed has some ability to manoeuver that it doesn’t possess today, and that it had run out of by early 2009, when it had to turn to special bond-buying programs to stimulate the economy. It’s much easier to simply unwind a rate increase than it is to put in place a complex multibillion-dollar bond-buying scheme. By 2pm ET, we’ll all know which side of the fence Yellen and her fellow policymakers have landed on. At least until the time of their next meeting, in late October. |