Why Raise Interest Rates Now?

Financial FAQs

The Federal Reserve is warning about the consequences of the just passed tax reform bill, which includes adding some $1.5 trillion to the federal debt in ten years. New York Fed President William Dudley says it will put too much money into the economy (via drop in corporate tax rate to 21 percent, and maximum personal rate to 37 percent), which will boost inflation to unacceptable levels. Dudley said the U.S. central bank may have to “press harder on the brakes” at some point over the next few years, increasing the risk of a hard landing for the economy, because of the new tax bill.

Once again, we are seeing what the Fed might do to stop this economic expansion, just as Fed Chair Greenspan did in 2007 by raising the Fed’s rates 16 times to stop the GW Bush expansion (and housing bubble) that led to the Great Recession.

Greenspan’s actions raised interest rates too fast on all the so-called liar loans with negative amortization, and put house payments out of range for the less qualified; many of whom had never owned a home, or had to admit their real incomes; which led to the busted housing bubble.

The Fed could make the same mistake in the current growth cycle with retail sales booming and very little inflation. The Fed has been too occupied with inflation since the wild inflation years of 1970, when they should be more concerned about maintaining adequate economic growth, which has been averaging just 2.1 percent since the end of the Great Recession.

Graph: Econoday

Retail sales rose 4.2 percent in 2017, with very little inflation even on the horizon. Retail sales rise 5 to 6 percent when the economy is growing for everyone, but inflation rates are also higher—in the 3 to 5 percent range historically. This is because the Fed is most sensitive to rising wages and salaries that make up two-thirds of product costs as an indicator of future inflation, as it did in the seventies.

By wanting to hold inflation to a 2 percent target, the Fed since the 1970s has been more concerned with tamping down household incomes, which is not the way to enable households to better themselves financially and move up the socio-economic ladder, as was possible prior to the 1970s.

Graph: Econoday

The Consumer Price Index, our best measure of retail prices, is still holding at 2 percent as it has for several years. But the core CPI index without food and energy prices plunged to 0 percent inflation in 2015 as the graph shows, and been slow to return to the 2 percent range. That’s hardly a sign of incipient inflation, but rather a sign of insufficient demand for goods and services, which in turn means household incomes are not rising fast enough to stay ahead of inflation, since consumers support two-thirds of all economic activity in the U.S. economy.

One can say the Federal Reserve has been too much in league with Big Business and multi-national corporations since the 1970s; which has kept production costs low and corporate profits at their highest levels in history as a percentage on national income.

This means we have to ‘modernize’ the Fed’s attitude about inflation, if we want to aid household incomes. Fed Governors should allow more inflation before raising interest rates further. Now is the time to be more concerned about the financial health of employees over corporate profits.

Harlan Green © 2018

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