Hiking interest rates must be on Federal Reserve’s agenda
The Federal Reserve needs to raise interest rates to allow the long-awaited sustainable economic growth to occur.
Since 2008, the Fed has held interest rates near zero. This violates the fundamental concept called the social rate of time preference, which is essentially a natural rate of interest created by the consumers.
When interest rates are artificially low, people have no incentive to save. Their only choice is to spend all of the money they earn.
The reason why the Fed now uses interest rates to attempt to stimulate economic growth can be seen by understanding the method to their madness.
The problem with low interest rates is they send false signals to investors who believe that it is a good time to tackle long-term projects. Right now, Federal Reserve Chair Janet Yellen has those investors biting their nails waiting for the next hike.
It is ultimately her decision to raise rates or keep them at zero.
The Fed controls the U.S. markets to the point of manipulation. For example, in March 2015, when Yellen hinted that rates were unlikely to increase at their April meeting, the stock market soared. But when Fed slightly increased rates, the stock market had the worst opening in years.
If this is not market power, I don’t know what is. What will happen in the short run when Fed hikes the rates?
It is difficult to say, investors do know that it is coming soon. This will soften some of the blow but the American people will be the ones to bite the bullet. Long-term R&D, growth in the labor markets and all of the new economic growth will come to a halt.
The longer the Fed waits, the worse it will be because investors and businesses will not allocate their money properly. While interest rates are at zero, they may feel like it is time to start ten, twenty, or longer projects that are now affordable to begin.
They will hire workers, buy materials, invest time and other resources into these projects. Once interest rates increase, these projects will no longer become feasible in the long run and businesses will need to cancel them. Workers are laid off, resources are wasted.
The Fed needs to act now in order to minimize the damage that will be done.
Some large investors are calling out the Fed on their cowardice. Bill Gross, co-founder and co-chief investment officer of Pacific Investment Management Company, has discussed the Fed’s creation of $11 trillion worth of debt to keep interest rates low for this long.
Obviously correlation is not causation, but we need to look toward common sense. We can’t expect different results if we keep using the same solution to fix a problem.
Although the Fed vowed to raise rates four times in 2016, we know now that it may only hike twice or not at all. Sources predict that if it does happen, it will be after the presidential election.
This motion could not be more detrimental to the people. The Fed is supposed to be a separate, non-governmental entity even though overlooking it is a president-appointed individual. Its actions should not depend on who fills the Oval Office, but instead what is right for the economy.
The only way to bounce the economy back is to let it happen without intervention. The fallout from the years of near non-existent interest rates will be difficult to shoulder, but through time and savings sustainable growth will reoccur.
It’s time for the Fed to accept that this economy cannot be powered by forced consumption, artificial credit and quantitative easing. Encourage savings and increase the interest rates.
Opinion columnist John Brucato is an economic senior and can be reached at [email protected]