The U.S. economy is chugging along. Not at high speed, but at a steady 2.25 percent annual rate, with retailers stocking up in anticipation of a very merry holiday season. The unemployment rate is down to 5.1 percent, according to the Federal Reserve Board headed lower to its “long-run normal” rate, and employers in many sectors are scrambling to find workers with the skills they need. Cars are moving off dealers’ lots and the housing industry is, if not booming, recovering its mojo, whatever that modern phrase means. Inflation is tame, but its failure to rise is due primarily to factors that Federal Reserve Board Chairwoman Janet Yellen told the press after the Fed’s monetary policy gurus met in solemn conclave are “transitory … will fade over time,”. So, with the economy “notably stronger” than when the bank’s economists last looked, “performing well [and] expect[ed] to continue to do so”; the jobs market more or less at full employment as traditionally measured; and inflation likely to increase once the decline in oil and import prices runs their course, the Board chairwoman announced on Thursday that she was ending close to a decade of zero interest rates and that the Fed would raise rates by 0.25 percent. Except she didn’t.
So St. Augustine’s monetary policy remains in effect. Yellen would be made chaste, but not yet. And for a new reason. She might well have said that the Fed is not prepared to raise rates just yet because inflation is too far below the bank’s 2 percent-increase target. She might have said that the Fed is staying its hand because although the unemployment rate is low, too many workers remain on the sidelines of the job market or are involuntarily working short hours. Period. She did indeed cite both those things. Plus a new criterion that must be met before the period of chastity ends. It seems world markets are volatile. “The outlook abroad appears to have become more uncertain of late, and heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets.”
This is no minor change in policy. Larry Lindsey, a former Fed governor, tells clients, “This is the first time in memory that global developments have taken such a prominent role in the Fed’s decision….it is hard to read the statement as anything other than international developments as being key to liftoff.”
Former Fed governors, always or almost always protective of the institution, don’t quarrel with the monetary policy committee’s decision. Nor do other defenders of the Fed. After all, a good case can be made for waiting to raise rates until inflation shows its hand, and the labor market tightens sufficiently to trigger a broad-based and significant increase in wages, which for many workers and families remain stuck at levels below those prevailing before the Great Recession: according to the Census Bureau, median household income, adjusted for inflation, was 6.5 percent lower last year than in 2007, when the Great Recession began. The Fed did quite properly note that the strong dollar is likely to cut into net exports, putting downward pressure on economic growth, and also keeping import prices and therefore inflation down. All the stuff of which past policy was made. All measurable. All well understood by markets. All justifying leaving rates where they are.
But now Yellen & Co. have increased uncertainty. Not only must investors watch the monthly jobs report and other data on the labor market. Not only must they keep an eye on the inflation rate and on inflationary expectations. Not only must they peer into their very clouded crystal balls to see whether growth is accelerating and whether “domestic spending appears sufficiently robust” to warrant a rate rise. They now must decide when the international situation is less “uncertain”, when “growth in China and other emerging markets” satisfies the Fed’s economic forecasters – not known for the accuracy of their predictions of the course of the US economy – that the era of zero interest rates can be brought to an end. Markets dislike uncertainty, and the Fed has just increased uncertainty by a not inconsiderable amount.
As with all policy decisions, the decision to hold at zero has winners and losers. The biggest losers, of course, are savers, especially small savers who cannot take on the amount of risk necessary to earn a decent return. The political consequences of continuing this policy might cause Yellen a few sleepless nights. The 2016 election cycle is well under way. Vying for the Republican nomination are several critics of the Fed. Some want to force the Fed to set hard rules to guide its monetary policy decisions. Other critics would have it submit to congressional audits of those policy decisions, seriously diluting its “independence”. The zero-interest rate policy, which has deprived denizens of Main Street an opportunity to earn a bit on their savings, while driving up the value of shares and other assets of denizens of Wall Street, is seen as one of the principal causes of rising inequality. Yellen will find herself under fire not only from the Fed’s traditional foes on the Left of the Democratic party who object to any plans to raise rates, but from the Right of the Republican party, which feels zero interest rates are distorting the economy by encouraging excessive and destabilizing borrowing, for which the poster boy is Lehman Brothers.
The small saver is not the only loser from the Fed’s decision not to raise rates. A companion-in-disappointment is the banking sector. Studies show that when interest rates go up small savers do benefit from higher returns on their savings, but that the banks paying out those higher rates also benefit. Erika Najarian, head of equity research at the Bank of America, reports that in 2006 banks passed along a mere 17 percent of the increase in interest rates to their depositors. The rising margin between what banks pay depositors and what they charge borrowers when they lend out those deposits translates into higher profits. Small savers’ smiles at increased returns on their certificates of deposit and savings accounts might change to tears when they face higher rates when seeking a mortgage or visiting their friendly car salesman.
As against the losers from the continued rate freeze, there are winners. The auto industry, its sales pumped up by cheap financing – zero interest for 72 months – and the housing industry, dependent for continued growth on low mortgage rates, are hoping rates don’t move up, ever, but at least until after Christmas. A view shared by the biggest debtor of all, to the tune of over $18 trillion and rising: the U.S. government. If the Fed indeed waits until it is clear that the Chinese authorities have righted their economy, the beneficiaries of low rates may be in for more than a Merry Christmas. They may be heading for a long period of the zero rates of which they are so fond.