Fed Chairwoman Janet Yellen hinted at a possible interest rate increase by December 2015. The last time she titillated us with such a notion, the anticipated increase in interest rates was still born. The Fed lacks credibility with respect to utterances about interest rates and it is possible that interest rates will not rise. Remember that the central motivation for keeping interest rates low is to stimulate the economy by making the cost of money cheap, which would encourage investment and consumer spending. So talk about raising interest rates suggests, Ms. Yellen believes that despite some persistent weaknesses, the economy is doing well: the long-term projection for the economy is positive.
Wall Street has been an epic beneficiary of low interest rates and of the economic recovery! Main Street, however, has not been so fortunate. Interest rates have been treading water for about a decade because the Fed does not want to get in the way of the economic fragile recovery by making the cost of money higher. Quantitative easing (QE) was followed by Ms. Yellen's predecessor, Ben Bernanke, and continued when she took over the reins of the Fed. But why cheap money, namely low interest rates? Increasing the money supply via QE drives interest down and weakens the dollar. "The Fed has held rates near zero since late 2008 to spur U.S. growth and hiring amid the worst recession since the Great Depression." (See Crain's New York Business) The decision to raise interest rates seems to be driven by the apparent strength and sustainability of the economic recovery. The confident statement of higher interest rates might be indicative that the economy in trending in the right direction, as manifested by the drop in the unemployment rate to 5 percent and the rise in hourly wages to 2.5 percent from a protracted 2 percent. Both trends could reverse from of the TPP agreement, democrats and progressives distrust drawing from other trade agreements such as NAFTA that might have been responsible for the flight of good paying manufacturing jobs to Mexico.
There were two intended goals of the low-interest-rate policy: exports and private investment both of which could cause economic growth to metastasize. How? By making American exports more competitive in the global goods market. Low interest rates might also encourage higher levels of investment--in plant and equipment; and household consumption: homes, cars, computers, refrigerators, etc. Aggressively maintaining low interest rates (via liberal monetary policy) is tantamount to stoking economic combustion (exports and investment) for an economic growth. There might be some caveat about whether monetary policy is effective, however. There is scant evidence that exports have benefited from low interest rates or that private investment have been spurred. Further, China has willfully manipulated the value of the Yuan vis--vis the dollar to increase her exports to the U.S. A peg in the investment machinery is the unwillingness of businesses to invest in the economy because of the deficit. The argument that bringing down the deficit would restore confidence in the government has not seemed to materialize in the face of government declining deficits. The deficit is project to be 4 percent of GDP instead of 7 percent last fiscal year.
The beneficiaries of low interest rates don't seem to care very much about Main Street--but more about their ability to maximize profits: Bankers pay a token rate of interest for money they borrow. Other beneficiaries of low interest rates have been companies that incur more debt for the purpose of paying dividends. Such use of borrowed funds runs contrary to traditional motives: investment in new capital formation. On the other hand, dividends traditionally are paid out of company profits. Cash advances from a bank can cost as much as 20 percent interest: Usury used to be against the law, but now it is practiced with impunity. And if that were not bad enough tugged away in the highway bill Congress saw it in its wisdom to continue to dole out (through the Fed--U.S. central bank) free money to Wall Street to the tune $17 billion in dividends to banks. Yet, it is verboten to raise taxes to fund the highway bill and okay to subsidize banks.
For retirees on a fixed income, the announcement of higher interest rates is welcome news if you have saved for many years and put your retirement money in interest bearing instruments. If you have say $1 million and interest rates are at 5 percent long term government bonds, you will earn $50,000 a year to supplement your retirement check. However, at a hypothetical 0.5 interest rate, your $1 million would mean a $5,000 return on your money. So in an odd sense, higher interest rates can lead to more consumer spending from people holding interest yielding financial documents.
New conspiracy: Obama tells Yellen not to increase interest rates until after the elections. This charge appears to have originated from Donald Trump. But the Fed is an independent (semi-autonomous) institution--yes, the chairperson and the board members are appointed by the president and approved by Congress. But the Fed in entrusted with monetary policy (manipulation of the country's money supply and interest rate) to influence economic performance--price stability, economic growth, and full employment. It is unlikely the president and the Fed chairwoman are in cahoots over interest rates. It precisely to obviate pressure from members of Congress (and the WH) seeking short-term political gains that the Fed is placed at arm's length of the political class. Ms. Yellen looks at indicators--inflation (which has been less than 2 percent) in 2013 and 2014 and flat in 2015, unemployment (which is 5 percent), and economic growth (which is 1.5 percent) in deciding whether to change the direction of monetary policy. Sometimes Congress makes veil threats to rein in (i.e. audit) the Fed if they do not like what the institution is doing. However, the independence of the Fed allows it to act based on economic conditions and not on the political whims of the Congress and White House. And it can take a long-term approach to monetary policy--compressing interest rates--as it has done since the Great Recession.