Monetary Policy

22

Author: William Pottenger

Sept. 17, The United States Federal Reserve reported that it would wait to raise interest rates. However, shortly after, Janet Yellen, the Chair of the Federal Reserve, suggested that the Fed may still raise the federal funds rate before the end of 2015. In my opinion, delaying the hike of interest rates by a few months hardly makes an impact on any long term economic issues; regardless, the Fed plays an interesting, yet increasingly complex, role as economies become more interdependent.

While the Fed’s primary focus is to govern the United States’ economy, it must also consider the status of the international economy when determining its monetary policy. The United States’ economy plays a much different role now than it did in 1913, when the Fed was established.

For one, the United States’ economy is more reliant on non-manufacturing industries, like finance and technology, than in the early 20th century. This is evident by the portion of Gross Domestic Product that is exports of goods and services, which the World Bank puts at 13.5 percent.

Second, the amount of trade that now goes on in U.S. dollar-denominated currency means changing U.S. rates can send economic ripples across the globe.

Paul Krugman, Columnist from The New York Times, writes that the Fed should wait to raise rates until excessive inflation is imminent. Krugman argues that while inflation remains well below the Fed’s target rate of 2 percent, like it currently is, there is no reason to raise rates. If the Fed does pull the trigger too early, he claims, the U.S. economy could possibly lose millions of jobs which would not have been lost otherwise.

On the other hand, Stephen King, the senior economic adviser at HSBC, believes that the Fed should finally raise rates for the first time since 2006. His opinion, elaborated in an article from The Economist, holds that maintaining rock bottom interest rates is allowing businesses, which would fail if rates were raised, to continue to operate. Furthermore, he examines the broader results of quantitative easing and currency devaluation, which are the two main tools recently used by central banks to fend off deflation.

Japan’s economy is an example that supports Mr. King’s point. Shinzo Abe, the prime minister of Japan, implemented “Abenomics,” which led the economy to grow at a paltry average of 0.8 percent since he retained power three years ago. Another example that supports Mr. King’s stance is the Euro Zone. After widely implementing quantitative easing, the E.U. has experienced dismal growth of about 0.4 percent, according to a report from The Economist.

Weighing both sides of the coin, I side more toward patience. I think there are valid concerns from both sides. However, I see more devastating effects from the Fed raising rates too soon, rather than raising rates too late. The political right in the U.S. worries that keeping rates too low for too long could lead to a similar situation as the high inflation of the 1970’s in the U.S. Although I take both the political left and right’s concerns seriously, I strongly believe that waiting a extra few months will have limited effects either way.

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