Analysts and investors have been searching for clues as to whether Federal Reserve policymakers will begin raising interest rates when they meet next week. However, globalization makes that decision a lot less important than in years past.
Keeping interest rates low for prolonged periods of time imposes distortions on the economy. For example, lower earnings on Certificates of Deposit forces many seniors to take part-time jobs to supplement pensions and Social Security—this displaces younger job seekers and contributes to lower labor force participation among prime working age adults.
Holding short-term interest rates near zero makes conventional loans less profitable and encourages the large banks to focus more on trading in securities and private equity deals—those flip assets and repay loans quickly but contribute little to growth and jobs creation.
Prolonged low mortgage rates push up land values in hot markets like Manhattan to levels not easily sustained when interest rates are normalized. And low rates encourage corporations to take on more debt—often to boost stock prices artificially by buying back shares.
Yet, as the Fed raises rates, both the domestic economy and global markets will push back.
In the second quarter, GDP grew at a robust 3.7 percent pace, but recent jobs data indicates a stronger dollar against Asian currencies is slowing U.S. manufacturing outside the auto patch, and Detroit is resorting to zero percent financing to keep its cars moving off dealer lots.
Falling gas prices have boosted car sales and broader consumer spending, but those cannot tumble down indefinitely.
Overall, the economy is returning to moderate—though by historic standards hardly robust—economic growth, and can hardly sustain quickly rising medium and longer term interest rates—especially in the key auto and housing sectors.
The Fed’s primary policy tool is to virtually set the banks’ overnight borrowing rate—the federal funds rate—which has been near zero since June 2008. However, the overall impact of Fed policy tightening depends importantly on whether increasing that rate significantly pushes up rates on mortgages, corporate and municipal bonds, and other longer term borrowing.
Leave A Comment