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Commentary By Diana Furchtgott-Roth

Why the Fed Should Raise Rates

Economics, Economics Monetary Policy, Finance

New employment data for October led many to assume that a rate increase from the Federal Reserve is in the offing. “Strong Growth in Jobs May Encourage Fed to Raise Rates,” wrote the New York Times, and “Strong Jobs Report Strengthens Case for December Fed Rate Liftoff,” stated the Wall Street Journal.

Not only was the strength of the jobs report exaggerated, but the Fed should not depend on one month’s employment data, which will be revised several times, to decide when to raise rates. Rates have been too low for too long, and it is time for them to rise—no matter what the jobs report.

“The labor force participation rate, those who are employed or looking for work, is stuck at 62.4 percent, the same level as in 1977”

The Labor Department reported that the economy gained 271,000 jobs in October, and the unemployment rate declined to 5 percent.  One had to dig deep into the numbers to discover that all the gains were in the over-55 age category, and that employment among those aged 25 to 54 actually declined.  The 25 to 54 age group form the core of the productive labor force, and an increase in employment which leaves out these prime-age individuals calls into question the strength of the labor market.

The increase in employment came from those with less than a college education who are less likely to add to the economy’s productivity. The unemployment rate for those without a high school diploma declined by half a percentage point. It was unchanged for those with a college education, and rose for those with some college education.

The labor force participation rate, those who are employed or looking for work, is stuck at 62.4 percent, the same level as in 1977.  As the economy has gradually strengthened, people who dropped out show no signs of coming back.  In contrast to the UK, where labor force participation rates for prime-age British men and women have been rising, rates for similar Americans have been declining.

Despite these data, the Fed should not delay beginning its long-overdue rate increases.  An increase of 25 basis points in December will still leave the Fed in a position of substantial monetary accommodation.

“The Fed’s near-zero interest rates and quantitative easing have left the United States a Carter-era labor force participation rate and 2 percent GDP growth, much lower than even the Carter-era economy.”

Current low rates are impeding economic growth, discouraging saving, and increasing inequality.

The Fed’s near-zero interest rates and quantitative easing have left the United States a Carter-era labor force participation rate and 2 percent GDP growth, much lower than even the Carter-era economy.

The longer the Fed leaves rates low, the greater the danger of inflation. Levels of inflation depend not only on interest rates set by the Fed, but on the willingness of banks to lend.  It is difficult for the Fed to forecast a precise level of inflation and stick to it because its models are imprecise. The Fed regularly overpredicts GDP growth, and in 2007 its models did not forecast the recession.

Western economies’ experience of inflation in the 1970s and 1980s showed that eliminating inflation is no easy feat. The world does not need another bout of stagflation.

Inflation hurts savers, particularly retirees who have few other sources of income. It discourages people from storing assets for the future. It favors those with hard assets, such as real estate, and penalizes those who want to buy their first homes. The Fed’s policies are redistributing funds from small savers, who cannot get a return on their savings accounts, to owners of stocks and homes, who have seen their assets skyrocket.  This amounts to robbing the poor to pay the rich.

Keeping interest rates low is not only bad for savers, it is harmful for the economy.  When interest rates rise, many financial sectors will find adjustment difficult.  Interest rates in U.S. debt will rise, increasing the deficit.  Many businesses predicated on low interest rates will fail.

“Central bankers, including the Federal Reserve, cannot pretend that easy money is a successful monetary policy.”

Central bankers, including the Federal Reserve, cannot pretend that easy money is a successful monetary policy. If easy money led to economic growth, countries would just have to lower rates to become economic winners.  Over the past four years, the race to the bottom by the Fed, the Bank of England, the European Central Bank, and the Bank of Japan has not let to faster economic growth.  Quite the reverse.

The United States has performed slightly better than other economies, not because easy money is a respectable policy, but because many individuals and institutions still look to the dollar as a safe haven in times of trouble.  With global terrorism on the rise and seemingly insurmountable challenges facing every economy, the world today has more than its fair share of troubles.

Everyone, particularly seniors, will be better when the Fed abandons its low interest rate policy. Over six years into the recovery, labor force participation rates are at 1977 levels. The Carter administration and Carter Fed are remembered for little more than some of the worst economic policies in history. Despite such ineptitude, the Carter economy grew at more than 3 percent annually, substantially more than the current 2 percent growth rate.  Obama’s Fed is making the Carter administration appear to be clever.  Independent of the employment numbers, now is the time to raise rates.

This piece originally appeared in CapX