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September 01, 2015 at 09:00 AM
(Bloomberg View) — With the recent market turmoil, the easy-money choir is again calling for the Federal Reserve to put off raising interest rates. But this could be dangerous to financial stability and the economy. It would only create more uncertainty and further distort the capital markets, delaying the return to sound economic growth based on market fundamentals.
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After nine years of no rate hikes, it’s time to begin returning to normal. It’s true there’s no inflation. And, yes, the economy is middling. But neither of those conditions justifies maintaining the zero-bound interest policy.
Those who argue against raising rates rest their case on two arguments, both of which misunderstand the effects on the real economy and the financial markets. The first is that the economy and the labor market are still too weak. In particular, there is the concern that higher rates would stymie a housing-market recovery that’s one of the main drivers of current U.S. economic growth. But this concern is misplaced.
To be sure, certain parts of the housing market have not yet fully healed. But continued zero-bound interest rates can do little to help those heavily overbuilt and depressed areas. Meanwhile, in other areas, they may push some homes back up into valuations frothier than even those seen during the 2008 housing bubble. It would be safer to let the market set long-term interest rates.
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Even then, an increase in the Fed’s short-term rates would probably have only a minimal effect. That’s what the market is telling us now. When the market is allowed to work, inflation expectations play a big role in determining long-term rates. And recent moves in the yield curve and mortgage rates suggest that these expectations are so low that long-term rates will also remain historically low. This, in turn, will keep the 30-year mortgage affordable. Moreover, to the extent that returning to a normal interest-rate policy affects inflation expectations, it may work to keep the long-term rates low. Consider that, in recent weeks, as the potential for a rate hike has looked more certain, long-term rates went down, suggesting that mortgage rates will remain low even if the fed funds rate rises.
In short, the data we have for housing and infrastructure investment suggest that the first 25, 50 or even 100 basis points of policy normalization will have very little to no effect on these activities and thus little or no effect on the real economy. If anything, a rate rise might help dampen a little of the froth that is evident in some markets. With home prices hovering at or above their 2008 highs, a little slowdown in price increases could be a good thing.
Those opposed to a rate rise also worry that it would further drive up the value of the dollar, hurting trade and stoking further turmoil in emerging markets. Yes, a further rise in the value of the dollar would add to the risk of capital flight from emerging markets. But capital is leaving emerging markets for many reasons that are unrelated to interest rate differentials or even emerging markets’ difficulty servicing their dollar-denominated debt.
