CAUTIONING THE FED

Federal Reserve officials pushed its benchmark short-term interest rate to near zero in December 2008 in order to spur borrowing, spending and investment during the global financial crisis. This week the Fed will decide at its Sept 16-17 policy meeting whether to raise rates for the first time in nine years. Some Fed officials would like to do so because the job market is improving at a rapid pace. However, current global turmoil suggests the Fed will be cautious about starting the process to normalise monetary policy, especially raising rates. Indications of a weaker global economy have increased the uncertainty surrounding policymakers’ economic growth and inflation forecasts. With international markets feeling the pressure from China’s economic slump and recent financial market turbulence, there are conflicting pressures facing the Fed as it prepares to make its interest-rate decision. Earlier, the US Labor Department reported that employers added 173,000 jobs in August, lower than the expected 217,000 jobs. The news provided fuel to both sides of the rate-hike debate. As well as the new jobs added, the unemployment rate has fallen from a peak of 10% in 2009 to 5.1% last month.

In light of these situations, inflation is currently too low at 1.2%, compared with the Fed’s 2% target. Inflation could turn out to be lower because of a rising dollar, falling commodity prices and China’s slowdown. These concerns suggest that the Fed may hold rates steady for now, until it is sure that the global economy is not heading into broader trouble. Although unemployment has fallen considerably in the US, any Fed interest rate rise would come at a slow pace. Examples of countries who raised their interest rates at the wrong time are Japan, Sweden and the euro zone. Their jobless rates had barely decreased when their central banks began to tighten their policies. As a result, their economies fell into recession and also suffered from deflation. Fed chairwoman Janet Yellen now faces her most difficult decision. If the Fed keeps rates low for too long, it could breed financial excesses that might hurt the economy later. And if it increases the rate it has to be sure there will not be an overreaction. The Fed also has meetings scheduled for October and December, so it has options if it does not move on the rates in September.

The question remains: Is this the right time for an increase?