Will it or won't it raise interest rates? After the wild turbulence in global stock markets in recent days, all eyes are now on Washington, where the U.S. Federal Reserve is headquartered. The Fed had intended to hazard the first rate hike in nine years in September. But the roller-coaster ride in international financial markets now makes this step seem more unlikely by the fall.
Although the Fed has yet to give any indication of its intentions, there is no lack of voices that are cautioning the central bank against raising interest rates. The market crash emanating from China immediately brought prominent U.S. economists like Larry Summers into the arena. A rate increase at this point would be a "dangerous mistake," said Mr. Summers and other fans of cheap central bank money.
Mr. Summers and other voices with close ties to Wall Street certainly come armed with good arguments. They say that inflation is still too low in the United States and is being pushed down further by plunging commodity prices. In their view, economic growth is too weak and would be stifled by higher interest rates. Besides, they add, a Fed rate hike would risk turning the current market crash into a new global financial crisis.
Postponing the move until December would certainly be advisable. But an even longer delay would only further postpone the moment of truth – and allow even greater risks to build up in the interim.
None of these arguments is incorrect. Still, they do not support the notion of continuing the failed experiment of combating crisis with cheap money. It has been a failure because the U.S. economy, six years after its last recession, has only achieved weak and fragile growth, despite unprecedented low interest rates.
The many dollars generated as a result of quantitative easing and the zero-interest rate phase have been funneled to many places – just not the ones to which the Fed had wanted to see the money go. Companies are hording cash instead of investing it. The rapid rise in stock prices in recent years has not generated an equally-rapid economic upturn. In the credit markets, the money has gone into home mortgages and emerging market debt instead of infrastructure, factories and consumption.
Finally, the era of low interest rates is also partly responsible for the current upheavals in financial markets. The Fed's monetary policy has allowed far too much money to flow into emerging markets, thereby exporting bubbles. In other words, global financial stability has suffered greatly as a result of a glut of money that has lasted for years.
The idea that a rate hike in September could exacerbate the current panic in the markets and send companies into a state of shock is undoubtedly a very real risk. For that reason, postponing the move until December would certainly be advisable. But an even longer delay would only further postpone the moment of truth – and allow even greater risks to build up in the interim.
Euphoria and panic are the worst advisers on the stock market. The same mantra applies to monetary policy.
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