Why the Fed is Still Hesitating About Raising its Interest Rates
Published in Les Échos
(France) on 27 May 2015
by Jean-Marc Vittori (link to original)
(France) on 27 May 2015
by Jean-Marc Vittori (link to original)
Translated from
by Thomas Seligmann.
Edited by Helaine Schweitzer.
Stay free. Free to decide to raise the interest rates for the first time in a decade at the right time, a decision which risks sending thousands of billions of dollars flying off to the other side of the planet. This is the obsession of Federal Reserve Board Chair Janet Yellen. Having a fixed schedule is out of the question. Last month, investors were saying the Fed wouldn't increase its rates at a meeting without having a press conference — only every other meeting of the Federal Open Market Committee, which directs monetary policy, is followed by a press conference. Too restrictive! At the end of April, the Fed tested a system allowing for an impromptu conference over the phone. The same investors have been stating clearly these last few weeks that they are expecting the increase to happen in 2016. Too demanding! On Friday, May 22, Yellen explained, "It will be appropriate at some point this year to take the initial step." Even if it means you then have to explain that reality has changed...
After having been guided by the goal of lowering unemployment, the Fed's policy is now "data-driven," guided according to the state of the American economy, which is revealed by a huge array of indicators. Suffice it to say that it is hesitating like never before in its history. Because an initial rate increase is its most delicate mission, as if, "to take away the punch bowl just as the party gets going," according to William McChesney Martin, Jr., who led the Fed for two decades after the war — because the stakes are colossal after the worst financial crisis for almost a century, but also because the uncertainty about the true state of the American economy, and beyond that, the cost of borrowing money, is immense.
During a speech in March, Janet Yellen focused on the "real equilibrium interest rate," which has to guide the Fed's monetary policy. This rate is supposed to allow the central bank to achieve its two main objectives: maximum employment and stable prices. Among the dozens of methods used to assess it, the one cited by Yellen, which was devised by Thomas Laubach, who works at the Fed, and John Williams, current president of the Federal Reserve Bank of San Francisco,, is today showing.... a negative rate. Yellen explains that this is due to "headwinds" which have been blowing since the financial crisis: It's more difficult to get credit, private individuals want to clear their debts and a restrictive budgetary policy and uncertainty are weighing on investment. The winds weakened in 2014. Therefore, the whole issue is knowing when the neutral rate will climb again, and how fast.
But the mechanics of inflation, like those of employment, no longer work like they used to. As far as prices are concerned, salaries aren't showing the slightest sign of surging. The increase in the hourly wage is less than 2 percent. New technologies and growing competition from emerging ones are burdening low salaries. The migration of factories from the north of the U.S. to the south, which is less unionized, is decreasing the level and therefore the cost of social protection. Can the labor market still set a spiral of price increases in motion? Nothing is less certain. And to complete the picture, temporary factors are bringing about deflation. The rising dollar, which has gained 15 percent over other currencies in one year, is causing import prices to fall. And the oil barrel's 50 percent decrease in price is pushing energy prices down.
It's even more complicated on the employment front. All is well at first glance, with only a 5.4 percent unemployment rate among active members of the population — twice as low as in France! But the activity rate — the proportion of 15-to-64-year-olds at work — which has decreased by four points since the crisis, is lower than in the 1970s. Half of this change is accounted for by the aging population; in the U.S., as in Europe, fewer people are working past the age of 50 or 55. What is causing the other half is a mystery. So the Fed is far from "maximum employment." And job creation, which had been accelerating since the beginning of 2014, seems to be slowing down.
The final point is the issue of the American economy’s growth, which vanished at the start of the year, also for temporary reasons — cold weather and strikes — but should bounce back. In a country that has once again become an oil producer, the fall in the price of black gold will, in any case, probably slow down national production by 0.5 percent to 1 percent this year. The rise of the dollar is putting a burden on exports. When oil production started again five years ago, some people questioned whether the growth cycle was coming to an end. Nobody knows how the financial system will react to a rate increase. The real estate industry shows signs of weakness whenever there is the slightest bit of panic about the cost of borrowing money ...
The Fed is hesitating all the more as it itself is being called in to question. Unlike the eurozone, in the U.S. there are always two or three bills hanging around Congress which are in favor of removing the central bank's independence. The movement's rise started when the banks were bailed out during the crisis, followed by the unconventional policies put in place as a consequence. The tea party Republicans are aggressive. Other legislators are taking up the matter. At the beginning of May, Democrat Elizabeth Warren and Republican David Vitter submitted a forceful text to the Fed with the aim of gaining congressional approval to come to the aid of a bank. This is so, despite the fact that the Fed was created following the crisis of 1907 to be the lender of last resort. In this context, there is no question of letting the criticism take hold! So, should interest rates be raised later at the risk of letting inflation become strong again? Should the Fed act straight away, at the risk of pushing the economy into recession? So that it can keep its freedom, the Fed, without a doubt, has not finished hesitating.
After having been guided by the goal of lowering unemployment, the Fed's policy is now "data-driven," guided according to the state of the American economy, which is revealed by a huge array of indicators. Suffice it to say that it is hesitating like never before in its history. Because an initial rate increase is its most delicate mission, as if, "to take away the punch bowl just as the party gets going," according to William McChesney Martin, Jr., who led the Fed for two decades after the war — because the stakes are colossal after the worst financial crisis for almost a century, but also because the uncertainty about the true state of the American economy, and beyond that, the cost of borrowing money, is immense.
During a speech in March, Janet Yellen focused on the "real equilibrium interest rate," which has to guide the Fed's monetary policy. This rate is supposed to allow the central bank to achieve its two main objectives: maximum employment and stable prices. Among the dozens of methods used to assess it, the one cited by Yellen, which was devised by Thomas Laubach, who works at the Fed, and John Williams, current president of the Federal Reserve Bank of San Francisco,, is today showing.... a negative rate. Yellen explains that this is due to "headwinds" which have been blowing since the financial crisis: It's more difficult to get credit, private individuals want to clear their debts and a restrictive budgetary policy and uncertainty are weighing on investment. The winds weakened in 2014. Therefore, the whole issue is knowing when the neutral rate will climb again, and how fast.
But the mechanics of inflation, like those of employment, no longer work like they used to. As far as prices are concerned, salaries aren't showing the slightest sign of surging. The increase in the hourly wage is less than 2 percent. New technologies and growing competition from emerging ones are burdening low salaries. The migration of factories from the north of the U.S. to the south, which is less unionized, is decreasing the level and therefore the cost of social protection. Can the labor market still set a spiral of price increases in motion? Nothing is less certain. And to complete the picture, temporary factors are bringing about deflation. The rising dollar, which has gained 15 percent over other currencies in one year, is causing import prices to fall. And the oil barrel's 50 percent decrease in price is pushing energy prices down.
It's even more complicated on the employment front. All is well at first glance, with only a 5.4 percent unemployment rate among active members of the population — twice as low as in France! But the activity rate — the proportion of 15-to-64-year-olds at work — which has decreased by four points since the crisis, is lower than in the 1970s. Half of this change is accounted for by the aging population; in the U.S., as in Europe, fewer people are working past the age of 50 or 55. What is causing the other half is a mystery. So the Fed is far from "maximum employment." And job creation, which had been accelerating since the beginning of 2014, seems to be slowing down.
The final point is the issue of the American economy’s growth, which vanished at the start of the year, also for temporary reasons — cold weather and strikes — but should bounce back. In a country that has once again become an oil producer, the fall in the price of black gold will, in any case, probably slow down national production by 0.5 percent to 1 percent this year. The rise of the dollar is putting a burden on exports. When oil production started again five years ago, some people questioned whether the growth cycle was coming to an end. Nobody knows how the financial system will react to a rate increase. The real estate industry shows signs of weakness whenever there is the slightest bit of panic about the cost of borrowing money ...
The Fed is hesitating all the more as it itself is being called in to question. Unlike the eurozone, in the U.S. there are always two or three bills hanging around Congress which are in favor of removing the central bank's independence. The movement's rise started when the banks were bailed out during the crisis, followed by the unconventional policies put in place as a consequence. The tea party Republicans are aggressive. Other legislators are taking up the matter. At the beginning of May, Democrat Elizabeth Warren and Republican David Vitter submitted a forceful text to the Fed with the aim of gaining congressional approval to come to the aid of a bank. This is so, despite the fact that the Fed was created following the crisis of 1907 to be the lender of last resort. In this context, there is no question of letting the criticism take hold! So, should interest rates be raised later at the risk of letting inflation become strong again? Should the Fed act straight away, at the risk of pushing the economy into recession? So that it can keep its freedom, the Fed, without a doubt, has not finished hesitating.
Next article![]( "Hillary’s Dangerous Opponent?")
