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Why the Fed Should Raise Interest Rates This Year: UBS Economist Drew Matus

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If economist Drew Matus had his way, Federal Reserve policymakers would raise interest rates when they meet again in late October.

The deputy Chief U.S. economist at UBS told the SIFMA/AICPA conference in New York that the Fed’s zero rate policy, which has persisted since December 2008, is creating risks for the economy and holding back growth.

Baby boomers concerned about having enough money to retire with as well as current retirees are saving more and spending less because they are earning next to nothing on their savings, said Matus. “The Fed is convinced instead that zero rates work, but they don’t when the majority of the population is moving toward retirement,” he said.

Boomers are also working longer to save more for retirement because of current low rates, becoming risk-averse, said Matus. “Taking rates from five to four to three percent may have helped, but below a certain level that becomes pointless,” Matus said. “That’s why no one invests and people are saving more than they should.”

Most economic forecasters do not expect Fed policymakers will raise rates in October, and many forecast no change for December, either. Although Federal Reserve Board Chair Janet Yellen said in late September that “it will likely be appropriate to raise the target range of the federal funds rate sometime later this year,” two Fed governors who are currently voting members of the policymaking Federal Open Market Committee said in separate statements this week that the Fed should not hike rates at all this year. Governors Daniel Tarullo and Lael Brainard first want to see signs that inflation is rising and approaching the Fed’s 2% target before voting for a rate increase.

The latest Consumer Price Index released Thursday supports their view of inflation. Consumer prices in September recorded their biggest decline in eight months and were unchanged over the past 12 months. Excluding food and energy the CPI rose 0.2% in September and 1.9% for the past 12 months, but the Fed’s favorite inflation indicator, core Personal Consumption Expenditures (PCE), is up just 1.3% through the end of September, well below its 2% target. Even after the Fed starts to raise rates — which it hasn’t done in more than nine years — that won’t reverse an accommodative monetary policy until its bloated balance sheet, now near $4.5 trillion, begins to shrink. “The balance sheet is three times larger than normal; it should be close to $1.5 trillion,” said Matus. He expects the unwinding of that excess “will be very messy,” creating “more dangers and volatility and risk.”

Overall, Matus, who once worked as an economist on the Fed’s open market desk, said the U.S. economy was healthy and growing at roughly 3%. Unemployment is low, the labor market is booming, and the U.S. consumer, whose spending accounts for about 70% of the economy, is in “good shape,” said Matus. In addition, he said, manufacturing is expanding,  the housing market has recovered, although it now accounts for less than 6% of the economy, and household formation is growing, and “for most of the economy there is very little fear.”  

He added, however, that the drop in oil prices — which is a major reason behind the low inflation rate — has slowed investment. Still, Matus said, the U.S. economy “can go for a long time at a low speed and not worry about crashing, but we’re not the fighter jet we used to be.”

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