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Why the Fed Should Raise Rates

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Why the Fed Should Raise Rates

Washington Examiner July 25, 2016
EconomicsMonetary Policy

Practically no one believes that the Fed will raise interest rates after its July meeting this week, but some Federal Reserve officials, such as Atlanta Fed President Dennis Lockhart and Dallas Fed President Robert Kaplan, are suggesting that rates could go up in September.

Rates have been too low for too long, and it is time for them to rise — regardless of what the jobs report shows.

With Fed Chair Janet Yellen constantly putting off rate increases, no one can be sure what will happen in the fall — even if the jobs reports for July and August are as rosy as the 287,000 June jobs increase.

The unemployment rate stands at 4.9 percent, and the latest inflation data show that the Consumer Price Index rose by more than 2 percent over the past year.

The Fed should not depend on 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 — regardless of what the jobs report shows.

Current low rates are impeding economic growth, discouraging saving, and increasing inequality. An increase of 25 basis points in September will still leave the Fed in a position of very loose monetary policy.

The Fed's near-zero interest rates have caused massive distortions in equity and real estate markets. Investors who would have had funds in savings accounts or Treasury bills are seeking returns in these sectors. This is a recipe for a bubble, which will cause a crisis when it pops.

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 across a multitude of economic measures. The Fed and the IMF regularly overpredict GDP growth, and in 2007 their 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, predominantly retirees who have few other sources of income besides their investments. It discourages people from storing assets for the future. It favors those with hard assets such as real estate since investment flows to physical assents, and this increase in price 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, which increases inequality.

Keeping interest rates low for such an unprecedented period of time is not only bad for savers, it is harmful for the economy. When interest rates rise, as they eventually must, many financial sectors will find adjustment difficult. Interest rates on 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 endlessly pursing 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.

Everyone, particularly seniors, will be better off when the Fed abandons its low interest rate policy. Independent of the employment numbers, now is the time to raise rates.

 

 

This piece originally appeared in the Washington Examiner

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Diana Furchtgott-Roth is a senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter here.

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