When expansions end and the economy tips into recession, one or the other is usually to blame.
In
the past, the culprit has frequently been fire — an overheating economy
and rising inflation — that prompted the central bank to push up
interest rates until they ultimately choked off growth. Ice is more
unusual, at least in the United States, but often more painful, as
excess capacity, weak demand and falling prices foster a deflationary
slump that can prove difficult to escape.
As the Federal Reserve
embarks on a new chapter in monetary policy, having raised rates on
Dec. 16 for the first time in nearly a decade, policy makers are acutely
aware of the risks posed by either possibility.
“Raising
rates the first time may have been the easy part; now comes the
challenging part,” said Mike Ryan, chief investment strategist for UBS
Wealth Management Americas.
Fed officials do not have to look far for real-world examples of what can go wrong.
European
central bankers raised rates twice in 2011, killing off a nascent
recovery and plunging the eurozone into a double-dip recession that it
is still struggling to overcome.
But being too slow to tighten the reins of monetary policy can prove perilous, too.
A series of steady quarter-point rate increases by the Fed
between 2004 and 2006 seemed prudent at the time, but in hindsight the
central bank has been blamed for moving too slowly, failing to head off
the economic catastrophe that followed the implosion of the housing
bubble in 2007.
The
biggest problem is that higher interest rates do not bite in
predictable ways. Not only do they take time to percolate through the
real economy, but there is also a difficult-to-foresee threshold at
which the impact can suddenly shift from mild to severe.
“I’m sure there is a tipping point,” Mr. Ryan said. “It’s just hard to know in advance precisely where that is.”
At
least for now, though, few analysts expect the Fed’s initial moves to
bring the nation’s six-and-a-half-year-old expansion to an abrupt end.
“The
rate hike this month and those next year may not really be felt until
2017,” said Michael Hanson, senior United States economist at Bank of
America Merrill Lynch. “Evidence from past cycles suggests it could take
a year, rather than the next quarter or two.”
Graphic
Why the Fed Raised Interest Rates
Officials said the economy was strong enough to keep
growing with a little less help from the central bank. They said rates
would rise slowly, but borrowing costs already have started to climb.
The Fed’s task this time is even more complicated because other central banks are leaning in the opposite direction.
With growth in Europe still sputtering, the European Central Bank
has belatedly turned to the tools embraced by the Fed several years
ago, buying up securities and pumping money into the financial system.
But even with some interest rates there in negative territory, Mario
Draghi, president of the E.C.B., is under pressure to loosen monetary
policy further.
In
Asia, the People’s Bank of China is also in easing mode, as officials
try to cushion what looks like an increasingly hard landing for the
economy there, the world’s second-largest. Similarly, Japan’s central
bank is keeping interest rates at rock-bottom levels to encourage
growth.
The
combination of lower rates abroad and rising ones at home is making the
United States dollar surge against other currencies. While that might
be good for American tourists heading overseas, it hurts American
manufacturers seeking export markets and makes imported goods more
competitive, undermining the country’s trade balance.
For
now, most economists say the danger of too little inflation outweighs
the risk of too much: Ice, in effect, may be more of a worry than fire.
“The
risk is skewed toward moving too fast,” said Michael Gapen, chief
United States economist at Barclays. “That’s especially true as the
strong dollar and lower-priced imports keep inflationary pressures at
bay in the United States.”
A History of Fed Leaders and Interest Rates
The chairwoman of the Federal Reserve has begun the
process of raising interest rates, a move that her predecessors have
taken in recent decades as they put their own distinctive stamp on the
economy.
Although
Mr. Gapen, like most seers on Wall Street, is generally upbeat about
the economy’s prospects next year, some of his colleagues elsewhere are
less sanguine. David Levy, a longtime private economist, is warning
clients that the Fed may be forced to reverse course as weakness in
China and emerging markets redounds to the United States.
The Fed’s rate increase on Wednesday, Mr. Levy cautioned, “may well mark a high point in economic expectations for 2016.”
In
its statement Wednesday about the decision to raise rates, the Fed
itself noted there had been a “shortfall” in terms of actual inflation’s
not measuring up to the central bank’s 2 percent goal, which it
considers helpful in supporting a more robust economy.
Scott
Anderson, chief economist at Bank of the West in San Francisco,
believes the reference to stubbornly low inflation is significant. “This
is new language,” he said. “The doves on monetary policy are saying
they will go along with the rate hike now, but want to see some
acknowledgment that low inflation is still a concern.”
For
his part, Mr. Anderson expects the economy to continue to grow at a
moderate annual pace of about 2.4 percent in 2016. If that forecast for
growth is correct, he predicts the Fed will raise rates three times next
year, lifting the benchmark rate to a range of 1 to 1.25 percent by the
end of 2016.
“Consumers
are cautious but they still have the capacity to spend,” Mr. Anderson
added. “Jobs and incomes are growing, debt levels are low and gas at
about $2 a gallon should help. When people realize the sky isn’t falling
because the Fed is raising rates, they will go back to their usual
spending habits and save the day.”
What Happens When the Fed Raises Rates, in One Rube Goldberg Machine
Exactly seven years ago, the Federal Reserve cut
interest rates to almost zero in order to nurse the ailing economy back
to health. Recently it changed direction. This is how it works.
A
growth rate of about 2 percent would be in line with the steady, but
disappointing, advance that has characterized the current recovery since
it began in mid-2009. By contrast, the economy grew by 3.8 percent in
2004 when the last tightening cycle began, and by 4 percent in 1994 when
an earlier round of rate hikes got underway.
The
comparatively weak recovery, which has left most Americans struggling
to maintain their standard of living, is the principal reason the Fed
has promised to move more slowly during this tightening cycle than in
past ones.
In
the mid-2000s, the Fed raised rates by 0.25 percentage point at every
meeting between June 2004 and June 2006, 17 straight increases that
lifted rates by more than four full percentage points over two years.
The
tightening campaign in the 1990s was even steeper, as rates moved up
three points in one year. Although that wreaked havoc on the stock and
bond markets in 1994, the move may have helped slow growth to a
sustainable pace and set the stage for the 1990s expansion to extend for
a full decade.
Many analysts say that the current expansion could display that kind of longevity.
“Expansions
don’t die of old age,” Mr. Ryan of UBS said, echoing comments by the
Fed chairwoman, Janet L. Yellen, at her news conference on Wednesday.
“They die from exhausted demand, but consumers aren’t exhausted.”
“And
the backdrop of low inflation won’t force the Fed into an aggressive
stance,” he predicted. “This expansion can go on for a while.”
No comments:
Post a Comment