Raise Rates Already
Since 1982, the Federal Reserve Bank of Kansas City has held an annual economic policy symposium in Jackson Hole, Wyoming. This event, typically in late August, is closely watched by the markets in search of guidance about future changes in interest rate policy. Given the Fed’s recent track record of raising rates slowly, but lowering them quickly, this ski resort with steep chutes and steady chairlifts seems a fitting back drop. Unfortunately, this track record seems set to continue as several Federal Reserve regional presidents revealed contradictory views regarding near term changes in interest rates. After the conference, the future’s curve implied only a 33% chance of a rate increase during the remainder of 2017. I think there should be no debate. The economy has been growing for eight years and appears to be accelerating in the second half of 2017. Current monetary policy is accommodative and risks of asset price bubbles, or other market distortions which could impact future growth, are increasing. Headline inflation (or lack thereof) is not telling the real story of building pressures in the economy.
Perhaps that last point is the most important. Why after eight years of economic growth do we still insist on negative real rates? If inflation is ONLY 1.7%, why is the fed funds rate at between 1 and 1.25%. There is a time for negative real interest rates, but punishing savers and rewarding borrowers for EIGHT YEARS?  Might that lead to some excessive borrowing and risk taking in the system? High yield spreads are currently very narrow, implying risk taking in the junk bond market. Emerging market sovereign spreads are similarly tight on a historical basis, as are emerging market corporate spreads. Does the Fed want U.S. savers to increase the amount they lend to EM countries and companies? According to the Wall Street Journal, even synthetic CDOs, “a villain of the global financial crisis” are back. Is this what the Fed is trying to accomplish?
So with animal spirits rising, what are we waiting for? Inflation to hit the Fed’s 2% target? First off, why 2%? Really, why is the Fed targeting 2% inflation? 2% compounds at a pretty decent clip over time. What’s wrong with 1.5%? In fact, given the Fed’s mandate of price stability, shouldn’t the target be zero? Last time I checked, the most stable price change is zero change, so why not target 0% inflation? One reason is the argument that deflation is harder to manage than inflation, so it is better to err on the side of inflation. The argument is that Paul Volcker taught us how to manage inflation, but managing deflation (creating inflation) is tricky. Robert Mugabe, Cristina Kirchner, and Nicolas Maduro have all managed to figure out how to create inflation! Are people seriously arguing that Zimbabwe has figured something out that the U.S. can’t? And was it really “easy” for Paul Volcker to raise the fed funds rate to 20%? I was too young to notice, but I’m guessing that wasn’t a lot of fun for him or anyone else. (In fact, I once heard someone ask Volcker, “If you knew then what you know now, what would you have done differently?” To which he replied, “I wouldn’t have taken the job.”)
Not all deflationary pressures are necessarily bad for the economy. Sure, if the economy is cratering, prices are falling, and everyone is delaying purchases, because they aren’t sure if they’ll have a job for much longer, while confident that prices will be lower in the future than they are today… that’s bad. But if prices fall because Apple invents a phone with GPS that enables Lyft to move people and goods more efficiently that’s… not bad. The Fed shouldn’t freak out and buy ever more assets, just because clever people have improved global productivity.
And they don’t….
A lot of people like to criticize the Fed. It’s easy to do, because historically, the face of the Fed, the chair, has been tough enough to take a punch and nice enough not to hit back. I am a big fan of Janet Yellen (and vice-chair Stan Fischer). Economists (real economists, people with actual PhDs who conduct research at places like Stanford) like to joke that Yellen’s husband won the Nobel prize (he did, in Economics), but that she’s the brains of the couple. It’s not much of a joke – Janet Yellen is brilliant. She is also incredibly kind and patient. You only need to watch one of her testimonies to congress to know that. While she may be in the twilight of her time at the Fed, I think she’s going to stay on that chairlift, and continue to winch rates higher (as she should!).
1Dear Fed, could we also please lose the 25 basis point range thing? We know the Fed Funds Target Rate is just a target, it’s in the name, so please, please can we go back to the target being a single number rather than a range?
2Full disclosure – I am biased. I am a net saver, so inflation hurts me while it helps those who are net debtors.
3“Spreads” are the difference in yield between two bond asset classes. Typically they refer to the deference in yield between U.S. treasuries and the asset class described (ie emerging market corporate spreads are the difference between yields on emerging market corporate bonds and U.S. treasury yields.) Tight spreads imply that the market is assigning less risk to an asset class than historical averages.
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