The Fed should shed its reserve and raise rates

Washington (Sept 13)  It is time for the US Federal Reserve to initiate what an International Monetary Fund working paper recently described as "arguably the most widely anticipated tightening of monetary policy in history", with short-term US rates having been close to zero for nearly seven years.

The emergency monetary policy conditions adopted by the Federal Reserve in December 2008, at the height of the global financial crisis, are no longer appropriate.

Also, a failure to raise rates could culminate in a situation where the Fed has no leeway to cut in the event of a US economic slowdown, which will inevitably occur at some point in the future.

While a Fed rate increase could unnerve US asset markets, given that "at present, a rise in [the] Fed Funds rate this year is widely anticipated by markets", as the IMF working paper said, the risk of not raising rates is the credibility of the Fed is called into question by market participants.

The Fed cannot appear to be in thrall to Wall Street.

Credibility aside, as for the policy considerations if rates are to be raised, while official US price data remains benign, Fed vice-chairman Stanley Fischer said on August 29 "there is good reason to believe that inflation will move higher".

Surely if the Fed thinks inflation will move higher, near zero interest rates, adopted in the first instance to deal with the consequences of a global financial crisis, have long since served their purpose and need to be raised.

At the same time, the continuing recovery in the US jobs market also underscores the argument that the current level of US rates is too low.

In his speech, Fischer noted the Fed's July policy statement requiring "some further improvement in the labour market", ahead of any increase in rates.

"From May through July, non-farm payroll employment gains have averaged 235,000 per month," Fischer said.

Except that was not the case.

Fischer was speaking ahead of the August jobs data released on September 4, which although the headline non-farm payroll figure of 173,000 underwhelmed, contained revisions that pushed up the payroll gains for May to July.

Non-farm payroll employment gains actually averaged 250,000 over the period Fischer alluded to in his speech, and that, it could be argued, is just the kind of evidence of some further improvement in the stock of labour market data that the Fed needs to raise rates.

The US unemployment rate hit 5.1 per cent in August, a near 71/2-year low; a level that, as Japan's Bank of Tokyo-Mitsubishi UFJ pointed out, the Fed did not expect to be achieved until the fourth quarter of next year.

"The ongoing tightening in labour market conditions is also beginning to result in evidence of firmer wage growth," Bank of Tokyo-Mitsubishi UFJ added.

Viewed through a US prism, can these economic conditions really be categorised as still requiring interest rates to be kept at the emergency setting deemed necessary some seven years ago?

Globally, the Fed also casts a wary eye over the international scene even as it sets policy that it feels best suits the needs of the US economy.

"At this moment, we are following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual," Fischer said on August 29.

Yet at the G20 meeting in Ankara on September 5 to 6, there was some evidence that Chinese policymakers were able to give some comfort to attendees that China's managed slowdown and economic transition remains on course.

Germany's Finance Minister, Wolfgang Schaeuble, said G20 finance chiefs agreed there was no need for nervousness over a slower pace of growth in China.

It remains to be seen whether the Fed shares Schaeuble's view, but if the US central bank is minded to raise rates, the G20 outcome can only make its decision easier.

Perhaps Jeffrey Lacker, president of the Richmond Fed, got to the heart of the matter when he spoke on the argument for a rate increase on September 4 in a speech titled "The Case against Further Delay".

"I am not arguing that the economy is perfect, but nor is it on the ropes, requiring zero interest rates to get it back into the ring," he said.

"It's time to align our monetary policy with the significant progress we have made."

Source: SCMP