Raising Rates Too Soon: The Mistake Central Banks Keep Making

If these people are worried about inflation they are NOT living in the present world. Most goods and services have INFLATED since 2008 and by a lot more than the FED has been willing to acknowledge. so, gas has gone down, but for me, that is the least of my worries. It will go back up and by a lot so they will make up any loss that they suffer now. since 2008 there have been a lot more goods in the stores that have come out in SMALLER package for the same or greater cost. 16 ounce loaf of bread--give me a break. 4.5 ounce yogurt, ice cream in less than half gallon sizes, so by my calculation, there has been at least a 25% increase in the cost of many food items, pet food now in 12 or 13 pound bags for the same as a 16 pound bag a few years ago.
Under what rock do these people live?

There are hints that a rise in interest may be justified: consumer debt for instance is increasing somewhat rapidly, although this could partly be due to the Fed signalling higher rates.

On the other hand, inflation is below target, wages (which would drive inflation on the demand side) are stagnant leaving only supply side drivers for inflation-- and on the supply side, raw materials prices are sagging.

The Fed could do something novel, like ramp the rate at a fraction of a basis point per month up or down rather than this antefragorian unit step nonsense that roils markets and works politicians into a froth-- a knob, not a switch.

Who exactly is it that the Fed believes they are going to protect from "inflation?"

Is it the young workers I'm employed with? They never discuss increases in prices; they do, constantly discuss how little they can buy with their wages.

Coincidentally we learn today from the Census Bureau that of 8 groups of household income only those whose incomes are already high to begin with have seen improvement since 2006.

Households at the 95th and 90th percentiles had larger earnings through 2014, the latest year for which data are available.

Income for all others was below 2006 levels.

So again, why is inflation even a concern? Why the constant stream of articles on finance sites telling us why the Fed should act and head off inflation.

What inflation? We're not even at the Fed's targeted inflation rate of 2%. "How can we have more inflation when we haven't had any?"

Yet here we're presented with the stories of central banks acting decisively to head off inflation; and failing their citizens. Our own Fed is meeting to discuss... what? low income? Income inequality? the amassing of wealth by a fraction of the human race?

No, they're terrified about inflation.

So I ask again: who exactly does the Fed think they're going to protect from inflation? Because I can guarantee you that none of the voices I listen to are expressing their concerns about income, lost opportunity, and unrealized wealth in that meeting.

The Fed is listening to one class and one class alone.
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The financial markets are burning up wealth with excessive volatility while the domestic wealth creating activities are not generating enough wealth to increase overall demand enough to cause inflationary pressures in the real economy. Unemployment has slowly decreased without any proportional increase in wealth amongst those who are working, except for a very small percentage of the population. The result is very slow increase of demand and thus no good reason for investors nor businesses to invest much in the real economy. However, businesses have been able to adapt to the close to flat increases in demand by improving efficiencies in their operations, and so they are mostly enjoying good profit margins and overall profits despite the slowly expanding economy. The financial markets are as active as they were before the great recession began and the result has been a great deal of volume and activity despite the slow real economic performance. This exchange of money is not reflective of a corresponding growth of domestic wealth and general increase of purchasing power and thus economic growth, which remains too slow to help most people afford to spend more which would drive up demand. The financial markets could use some higher interest rates to reduce the volatility in those markets but the real economy of the United States is still growing too slowly to justify higher interest rates which will reduce the buying power needed to support greater economic expansion.

Yes, there have been mistakes in the past, but no one is talking about a big jump in rates, and Yellen is pretty sharp and cautious.The present situation is unnatural, and perhaps that should be more concerning than any problems a gradual rate rise may cause. Our economy is in decent shape, and a rate drop is an essential tool that the Fed has been without for too long. The stock market will drop temporarily, but will be stronger in the long run.

Each of the examples described in this article is different and unique. Hard to generalize and reach a valid conclusion. Yes one can say don't raise rates too much too soon, but what is too much and what is too soon? No one knows, but the tiny rate increase under discussion is certainly not too much.

The Fed needs to get the rates off of zero. This will give them a little room to move in either direction looking forward as economic conditions dictate. A overnight rate closer to one percent will also start to allow savings accounts to pay more than zero to people on fixed incomes. At the same time it will still be low enough to be accommodative by historic standards. It also isn't clear how pinning the rate zero for more time is going to significantly help unemployment going forward. Nine years without a rate hike is unprecedented.

I have seen nothing that suggests a small rate increase will have any economic effect, except in the minds of investors who are worried about how other investors will react. The obsession over this by the financial media has no basis in reality.

The idea that inflation indubitably follows low unemployment rates is lazy thinking.
True, that is what has happened in the past, but WHY has it happened?
Because a tight labor market used to lead to higher wages, initiating inflation, i.e., more and more money chasing fewer and fewer goods.
Except now a tight labor market (the low unemployment rate) is not leading to higher wages.
So, duh.
The Fed is now working with a very different set of conditions for defining when inflation is going to kick in.
The unemployment rate is no longer a reliable signifier.

First- what have low interest rates created in terms of the real economy? I am not talking about the stock market- that is no longer in any way a reflection of the real economy.

The Fed's actions of QE and ZIRP have done nothing to help the real economy. The Fed's actions have acerbated conditions that will see the whole thing implode.

Easy money has seen stock buybacks rise to their highest level since they have been tracked since 1991. The captains of industry no longer think about how to grow their businesses, they are concerned with increasing the bottom line.

This unrelenting drive to push back costs to inflate profits is killing the system. Wages have stagnated since Nixon closed the gold window in 73'. Cheap labor overseas has decimated manufacturing in the U.S. Global trade deals are put into place by politicians who are compromised before they even step foot into office. Bankers and CEOs and corporations too, thanks to the Supreme Court, buy their candidates and have their lawyers write legislation that facilitates their desires.

The Central Bank's actions have helped these behemoths by providing easy money. The easy money has done nothing to help consumers and if consumption is 70% of our GDP then of course the economy is still limping. In 08' the economy had both its legs broken by the TBTF and too big to jail bankers and instead of our politicians taking the proper course they caved.

Raise rates now. It won't matter to main street. Wall Street can afford it.

For the States, it is more than the need to push for better economic growth. Instead, it should be the heavy debt that the government needs to pay off. With heavy budget deficit, the government is unable to manipulate the fundings that benefits the economy most. With QE, there is just going to be an increase in supply of USD that drives the money value down. This then worsens the debt when currency depreciates. Right now, the currency is appreciating but with China's economy being on the shaky edge, US is going to be greatly affected. Like what @WindSurfer said, they ignored the Keynesian economic theory when pushing for fiscal austerity.

In another words, to sum it up, US has too many issues to resolve. Yet, there are only a limited number of policies to solve the issues. However, there are contradicting outcomes. What else can the government do to save itself from all the trouble?

There is only one reason why the U.S. Central Bank feels forced to make any decision. It's due to Congress kicking the average American to the curb during and after the 2008 crash... like just so much trash.

In fact, we all know that the rich got richer, the poor got ignored, and the middle class got smaller. Poll any 100 people to find out that they consider Congress to be solidly in that "rich got richer" category.

There's not much of a case for raising rates now given inflation which is on the edge of deflation and volatility in financial markets. On the other hand despite all the hoopla 25 bips is hardly earth shattering although it would create some short term volatility. The probability is they'll delay until December but I guess we'll find out.

And with the recent departure of Gov Perry from the run for the Republican presidential nomination, let's not forget his contribution 4 yrs ago to the debate about monetary policy:

“If this guy [Bernanke] prints more money between now and the election, I dunno what y’all would do to him in Iowa but we would treat him pretty ugly down in Texas. Printing more money to play politics at this particular time in American history is almost treasonous in my opinion.”

No past action by the fed can be used to predict economic cycle fluctuations because we are in unchartered territory with the China card. China has broken every "dont fight the fed" cliche in history. We will soon learn what their multi-pronged, arbitrary and counter-intuitive measures have wrought. And it aint gonna be predictable, and it aint gonna be pretty. Prediction? Yeah, I got a prediction: PAIN!!

It won't be long before folks like Irwin will be making arguments for -5% Fed Funds and splitting the $.

To play around with the so-called recovery by testing the water with a rate increase is divorced from reality. The only people who would definitely benefit are a small group of people, creditors. The recovery is mostly an election-biased illusion, and we all know the unemployment figures do not really reflect how many people are without jobs who want them. To even suggest a rate increase comes from living in one of those mental bubbles that exclude the reality that this is a country of over 300 million people most of whom need their credit.

Don't over-complicate the matter. There will be no real recovery until the American people, the ones who really produce wealth, not just transfer it, have a lot more decent-paying jobs, which has just not happened. To suggest a rate increase is not only cruel in its effects but also very shortsighted. Policies that seem to benefit a few will in the long run really just "lower all boats."

"The fact that errors by the Fed and other central banks have all pointed the same direction the last several years does not mean that a rate increase this week would be a mistake.."

Yes it does. The idea that there's a danger of the economy overheating makes no sense. Unemployment is low because a lot of people gave up looking for a job. Wages have been flat for decades. People collecting wages are working for that income. People collecting interest are not.

Let the economy grow. It would definitely be a mistake to increase interest rates.

The Fed should be paying more attention to its own papers, as put out by Peneva and Rudd in May, showing that even if wages rise, there is almost no pass through that causes inflation:

http://www.federalreserve.gov/econresdata/feds/2015/files/2015042pap.pdf

We realize data such as this will be utterly ignored by the hawks; which is what makes it so instructive to debunking their mythology :)

The real problem is that the Fed's current ZIRP policy creates perverse incentives, which can be seen in the massive excess reserves that have accumulated (you know that there is a problem when banks are not coming close to maximizing their lending). ZIRP creates an inescapable trap, which should become increasingly clear considering Japan has been trying it for 20 years and the U.S. and Europe for about 7 years.

Personally, I think that the Fed should systematically unwind its massive balance sheet by doing QE in reverse (e.g. selling $85 billion a month in assets instead of buying assets as in QE3).

Looking at the historical fed funds rate history, the lowest monthly pre-ZIRP rate was 0.63% back in 1958. I think that we should let the rate rise to at least that high, but a 1% minimum would probably be better. If the economy can't grow at that low rate, it doesn't seem like lower rates than that will help.

Instead of financial manipulation, I would love to see an economic policy of full employment. The unemployment rate of 5% percent means nothing when so many black men are unemployed and laid off workers are filing for disability. Companies are speculating with cheap money, diluting their stock, instead of investing in r&d. The country is falling apart because of failing infrastructure. There are no apprenticeships. California has less than half of its public libraries since Prop 13. This is no longer a prosperous country.

Apparently, I must be the only one here that remembers a time (before 2008) when savers trusted their banks to reward them with higher interest rates, which they could withdraw while protecting the principal. We actually spent that extra income, bought stuff and boosted the economy...everybody was happy. If we don't raise the interest rates, nothing else will serve to boost the economy. Keeping the brakes on interest rates hurts mostly the middle class, quashing any incentives to deposit their hard-earned wages when banks give a return of zip to zero. Most of us wouldn't invest a dime in the stock-market today after we got a bashing from the Wall Street gurus and had to wave bye-bye to our 401(k) investments, so give us a break...raise the interest rates.

Since when we decide to look back only a few years and claim this is the history we should learnt from.

We used to have zero interest rate, cheap credit or high stock price. But at the end, we forget what interest rate means? why we need credit? and do we invest? right now the problem in US isn't quite like whether a rate hike will kill the recovery instead why we don't really invest to education or infrastructure to narrow the gap of (income/prospects) inequality and reset the engine to grow America Dream.

Without iPhone and Shale Gas, I couldn't really imagine what coding programmers and geologist working now. And there would not be any more sound recovery. This is a fortunate US embraced last couple years.

Low Rates isn't benefiting to any Low-income class, it just widens GAP and pass even more advantage to all sorts of wealthy class.

The big lesson: Letting politicians determine the economic 'truth' is like having the Pope decide scientific 'truth'. Galileo was held before the Inquisition in his day for his proof that the earth moved around the sun. These decisions should be based on sound economic principles with a track record of probable success, not on what a bunch of politicians wants to hear. Good for Bernake, but imagine the horrible political pressures he must have been under!

Seems like for several years there have been many voices weighing in on what path the Federal Reserve should pursue regarding monetary policy.

Why then, whenever concerns are raised related to the ongoing inadequacy of U.S. Government fiscal policy stimulus, the associated silence from these same voices is deafening?

Here we go again: what inflation?

Since 2008 financial crisis, after the collapses of the housing market and the stock market, our economy managed to turnaround ,without adequate fiscal stimulus, only with aggressive monetary policy by Fed, even though our economic growth determinants like annual productivity growth and annual growth of working-age population stagnated for long. Like EU or Japan, our conservative policy makers were loud 'inflation alarmists' and pushed fiscal austerity aggressively, ignoring Keynesian economic theory. This is the first tragedy of the 21st century that prolonged and deepened recession all over the world. Though stock market bubble is blatant and noises from Wall Street irritate most of the people, forgotten more than 30 years, I still think rate hike by Fed is premature. I don't think Mr. Fischer learned the lesson from the failure in Israel.

Maybe I missed it, but I have never heard or seen any analysis by the Fed of the consequences to the demand side of the monetary equation of zero-bound interest rates. In a consumer driven economy where the savings and buying power of the vast majority of those consumers are in savings accounts, money market accounts and investment grade bonds, driving the earning power of those instruments down while flooding the financial markets with liquidity which only trickles down to middle class consumers is "pushing on a rope" and relinquishing control over that liquidity to the large commercial banks a prime example of the "triumph of hope over experience".

It is no wonder that Zombies are a popular artistic character. That is simply because they exist in real life. Zombie corporations are doing more harm then good...isn't that how we counselled Japan?
Too much debt keeping bad and/or unnecessary corporations producing goods we don't need. The energy sector through loose lending has produced a glut of oil and created deflation.
Take the mustache of and look and this for what it is, another failed supply side solution. Supply side 4.0, gotta love it!

It is disturbing that too many financial reporters who should know better continue to argue for continuing today's low Fed rate indefinitely. It would be useful if more attention was paid to the negative consequences of today's liquidity trap and the need to consider how the optimum social discount rate would differ from today's low interest rate.

It's an extraordinary article Mr. Irwin. Those who forget the lessons of history are condemned to repeat it. As your examples show, and others (Chile, South Korea, Canada, New Zeland), a premature tightening of policy can be a grave mistake. The problem now is that there is no room for mistakes: if an early interest rate rise proves an error --kills the economic recovery, detonates financial market volatility-- there will be no room to ease policy. That's why the risks the Fed faces are asymmetric: it's much safer to err on the side of a little inflation and tighten policy later, than to err on the side of killing the recovery in the US (now the only world engine) and having nowhere to move.

Thursday's will be a momentous decision. If the Fed increases rates, it could prove to an economic policy mistake of historical proportions, much a Trichet's move in 2011 and the own Fed move in 1937.

Meanwhile, retirees and other conservative investors have been punished with miniscule yields on CDs and other instruments. hampering their spending, which would do the economy good. Seems like this policy has been great for financial firms at the expense of millions of people of modest means who could make good use of larger interest payments.

The low rates also have lightened pressure on the government to move closer to a balanced budget. (Whether you think that should be done with higher taxes or less spending is irrelevant.) That chicken will come home to roost someday.

Perhaps raising interest rates would improve the economy.

Right now, big institutions can borrow money for nearly nothing and use arbitrage and leverage to generate profits. They have no need to produce and sell goods and services. Raising interest rates would make this more difficult, but at .25% interest rates should have hardly any impact on the real economy.