(Bloomberg) — Some economists are suggesting that the best thing the Federal Reserve could do for the U.S. economy would be to raise interest rates for the first time in nearly a decade, mounting an argument that flies in the face of conventional economic wisdom.
Tightening, in light of the current circumstances, would actually be stimulative, on net, they argue.
“The reason [the Fed] should have raised rates in September and the reason, failing that, that it should do so this month isn’t that the economy can handle the pain but rather that it could do with the help,” David Kelly, chief global strategist at JPMorgan Asset Management, wrote in a recent research note.
The consensus view, steeped in decades of economic thought, maintains that higher rates encourage saving instead of spending by households and raises the cost of capital for businesses, weakening current demand. Higher interest rates could also be a negative for asset values, as income generated would be subject to a higher discount rate.
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The ensuing negative wealth effect would be a drag on consumption. An increase in interest rates is also typically accompanied by a rise in the U.S. dollar, which crimps competitiveness and weighs on production in the tradable goods sectors.
But in practice, the effects of liftoff might well be different this time, some analysts contend. For households and corporations, non-price factors like credit ratings or a lender’s regulatory requirements are the far bigger constraints on activity than the cost of carrying debt, and a pickup in interest rates would help alleviate some of these impediments.
Kelly notes that aspiring homeowners have to meet three criteria to qualify for a mortgage: sufficient savings for a down payment, an acceptable credit score, and proof that they can make their monthly payments. That final component is the most susceptible to rise along with interest rates, but is also “by far the easiest of those hurdles to surmount,” he wrote.
In fact, higher interest rates might actually add fuel to, rather than cool, the housing market.
Joe LaVorgna, chief U.S. economist at Deutsche Bank, observes that higher interest rates would be positive for banks’ net interest margins, thereby inducing them to loosen the lending spigots.
“Debt service is not the problem for people who want to take out a mortgage,” he said. “Lower rates and a flatter curve aren’t going to help the housing market too much if you can’t get a mortgage because standards are still too tight.”
For households, this sequence of ultralow rates for an extended period followed by a modest bump higher enables them to have their cake and eat it, too.
Mortgages and auto debt taken out in recent years have been primarily longer-term obligations with fixed rates, while most interest-bearing assets are short-term instruments that will provide a greater boost to household income once rates rise, according to Kelly. So on the liability side, there’s less scope for rising rates to eat into disposable income, and more upside on the asset side of the ledger.
“There’s roughly $10 trillion in the banking system that’s earning zero,” added LaVorgna. “Those people aren’t investing in the stock market; they’re keeping their money in cash and spending less because when you’re in a low-interest-rate environment, you don’t buy more, you save more.”