Yves here. I hope you’ll circulate this article widely. It explains why the Fed’s effort to depict interest rate increases as necessary given the state of the “recovery” and the prospects for inflation are obviously false. The rate rises are all about bolstering financial firm profits, as if banks have a right to them. In other words, this is a continuation of the process set forth in Simon Johnson’s landmark 2009 article, The Quiet Coup. From the overview:
The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets…recovery will fail unless we break the financial oligarchy that is blocking essential reform.
One could imagine a more honest case for rate increases: that sustained negative real yields promotes speculation (witness the proliferation of Silicon Valley unicorns), hurts retirees and savers, and puts the viability of long-term investors like life insurers and pension funds at risk. But given how weak this recovery is, and that deflationary pressures are strong, any rate increases should be accompanied by more fiscal spending. Yet the Fed has not said a peep on that front and instead hope the confidence fiary will come to the rescue.
The fact that the Fed is embarking on a policy that will perpetuate the financial system being outsized relative to the real economy, particularly when more and more academic studies confirm that that is negative for growth, confirms that the Fed needs fundamental governance changes to reduce bank influence and increase democratic accountability. A place to start might be having all the regional Fed presidents be nominated by the President and subject to Congressional approval.
By Gerald Epstein, Professor of Economics at the University of Massachusetts, Amherst
The Federal Reserve announced on Wednesday (December 16) that it would raise policy interest rates by ¼ to ½ of 1 percent end the seven year policy of keeping Fed interest rates near zero, and would embark on a path of “gradual” interest rate increases in order to “normalize” interest rates. This announcement had been long expected by pundits, economists and the financial markets, and, more to the point, had long been pushed by Wall Street and their supporters.
It was telling that the first question asked by a reporter in Fed Chair’s Janet Yellen’s press conference following the announcement was not a question at all. The reporter blurted out a sigh of relief: “Finally!” he exalted. The Financial Times’ Lex Column headline: “U.S. Monetary Policy At Last”. In fact the financial media have been huge cheerleaders for a rate hike. In the months leading up to this announcement, much of the business press had been pushing for an increase. In September, when the Fed did not raise rates, much of the financial press ran headlines like the this Wall Street Journal headline: “The FED Blinks”. The Journal was not alone with phrases like: “the open market committee sat on its hands.”. Blinking and hands sitting: these suggest lack of courage, weakness and worse. Neil Irwin of the New York Times, personalized it to Janet Yellen with a headline on September 17: “Why Yellen Blinked on Interest Rates”
Well, yesterday, Yellen did not blink and the financial press and many economists and pundits were clearly pleased. Yet, as the thoughtful members of the press and economists pointed out, economic conditions are not much better, and in some ways are worse, in December, than they had been in September. Dean Baker of the Center for Economic Policy Research (CEPR) wrote almost immediately after the decision multiple reasons why data do not support a decision to raise rates: He points out that while the official unemployment of 5% is not particularly high, “most other measures of the labor market are near recession levels”. The percentage of the workforce working part time but who really want full time jobs is near the highs reached after the 2001 recession. The percentage of workers willing to quit their jobs to look for a better job is also at near recession highs. “If we look at employment rates, the percentage of prime-age workers (ages 25-54) with jobs is still down by almost three full percentage points from the pre-recession peak.” Finally, wages stagnation is still significant, even despite some recent low gains.
The signs of weakness and uncertainty globally are also still strong. John Authers of the Financial Times shows in a series of graphs that market participants expect inflation to fall further, NOT rise to the 2% level expected by the Fed; oil prices continue tumbling which could be a source of demand for consumers, but, like other aspects of deflation, put a downward pressure on important sectors and, if they interact with excessive debt, can contribute to pressures for a debt deflation spiral; global equities have fallen along with oil and other commodity prices, perhaps a sign of weakening profit expectations; and importantly, the value of dollar continues to rise, which might help foreign exporters, but serves a drag on US economic production by making it less competitive. This problem is exacerbated by the fact that the European Central Bank is moving in the opposite direction by lowering interest rates — even into negative territory.
All of this raises the obvious question of how did Janet Yellen and the Federal Reserve justify their rate increase now, despite strong signs that there is little economic basis for doing so?
Call this the Fed’s “New Operation Twist”: an exercise, not in twisting the term structure of interest rates to lower long rates and raise short rates as in earlier times, but an exercise in twisted logic, plain and simple.
This was apparent in the Federal Reserve’s press release, and even more in Janet Yellen’s press conference following the Federal Open Market Operations (FMOC) meeting. Her justification for raising rates rested on several questionable, and even strange, twists of logic.
The first, and most important, is the confidence the Fed has that inflation will continue to rise toward its 2% target, even though, by raising rates, the Fed will be putting downward pressure on the economy. They are thus creating an additional “headwind” to join the other global forces in the domestic and global economies – weak demand in China, commodity market gluts and uncertainty over terrorism and global security –that all suggest that inflation will remain weak.
Part of the reason they believe inflation will rise despite the increase in interest rates and other negative forces, is that they believe with lower unemployment, workers will achieve the bargaining power to raise their real wages. But in the current context of weak bargaining rights, globalization by US multinational corporations, and the continued weakness in the labor market domestically, worker real wages are likely to continue doing what they have done for decades now: remain relatively stagnant.
These odd examples of twisted logic seem minor, though, compared to some of the more bizarre arguments made by Yellen and the Fed.
In her statement and answers to questions after her remarks, Yellen said several times that the increase in interest rates is a strong sign of the Federal Reserve’s confidence in the strength of the American Economy. Because, after all, if the US economy were not doing well, then of course, the Fed would not be raising rates, right?
Here is an example of the Fed trying to play the classic game of the “confidence fairy” – we will raise your confidence by pretending we are confident. But it is rather more like “whistling past the graveyard”: with the data out there for everyone to see, most are unlikely to be fooled. It is also a little like saying: we are going to get in our truck and run you over because we are confident that you are strong enough to take it.
And here is, perhaps the strangest twisted logic of all: Yellen said that they want to raise rates now, because they are worried that if there is a downward shock to the economy, with interest rates at the zero bound they will have fewer tools (less ammunition) to counteract the shock.
Doesn’t this sound like she is saying: we are going to create a downward shock, so later it is easier to counteract it?
The final example is the argument that they want to raise rates pre-emptively now, before there is any clear sign of excessive inflation, because lags in monetary policy mean that if they wait they might be too late and then they will have to raise rates more abruptly and this will be even more disruptive.
We must ask the question: who does more rapid increases disrupt? The answer is likely to be the speculative financial markets, and the banks who might find that the speculative positions they take have been mistaken. So here, in paying excessive concern for the financial speculative markets, the Fed is willing to raise interest rates before the labor market is really ready.
This also begs the question: where does this 2% inflation target come from? It is completely arbitrary, which even Bernanke, the architect of the new inflation targeting at the Fed, admits. Would it be better to allow a shallow rate increase trajectory at the appropriate time, and let inflation over-shoot its arbitrary 2% target, then risk prematurely nipping the recovery in the budd?
To be sure, Yellen repeatedly said that the increase in rates will be gradual. But projections by the Fed Policy Makers suggest anything but a gradual rate increase. These projections of the expectations of the policy makers (not their plans, to be clear) show interest rates rising to between 2 and 3% by the time the new President is inaugurated.
Why is it that Janet Yellen, clearly a very smart economist who is committed like, perhaps, no Fed Chair before her, to try to achieve full employment and reduce inequality would engage in such questionable arguments and problematic actions?
The most likely answer is probably that Yellen faces enormous pressure from her own committee and outside forces to raise rates sooner rather than later. These outside forces are the banks. A series of papers have shown that in general, bank profits increase with higher interest rates. Economists at the Bank for International Settlements (BIS) have done empirical work that suggests that higher interest rates improve bank profits; and others at the IMF have done careful empirical work suggesting that in the US higher interest rates raise income inequality.
But in the time of the Great Financial crisis and quantitative easing, the relationship between monetary policy, bank profits and inequality is actually more complicated than this. In a series of papers at the Institute for New Economic Thinking (INET), Juan Montecino and I show that Quantitative Easing by the Fed initially improved bank profitability and helped corporate profits in other sectors as well, such as automobiles and construction. It did also raise employment and helped workers and the middle class, but, at the same time, though, QE worsened income inequality, by delivering large asset price gains to the wealthiest Americans.
By the later phases of QE, though, most banks in the US did not continue benefiting from loose monetary policy and then the attitude of Wall Street toward expansionary policy likely faded. As Tom Ferguson and I showed in the case of prematurely aborted expansionary monetary policy in the 1930’s, the banks began to lose more from lower interest rates than they gained in asset price appreciation and expanded demand.
The result is that the more standard pattern identified by the IMF and BIS economists of lower interest rates hurting bank profits has likely returned. And with it has been the blistering pressure to raise rates.
Facing this pressure, Janet Yellen has most likely decided play a strategic game: give in to the demands from her colleagues for a move toward higher rates, while expecting to be able to drag her feet in the future on raising too rapidly, in the hope of keeping monetary policy “accommodative” along the way.
Will this gambit — which has caused her to twist her logic like a pretzel — work? It seems like a long shot. Finance has its long knives drawn and it has plenty of allies on its side. At the same time, though, the fragility of the global economy will weigh in on her side.
The tragedy, of course, is that this is not the game she should be playing. First, fiscal policy needs to be much more aggressive in promoting needed investment. Moreover, rather than beating a strategic retreat, Yellen and allies should be engaging in much more creative, direct job promotion and direct promotion of local infrastructure investment, as proposed by groups like QE for the People in the UK associated with Jeremy Corbyn and the Fedup Campaign, here in the US. To make that happen, we need to keep pushing. And fast.
The problem with self regulation as opposed to market regulation is people just don’t adequately impose moral hazard on themselves.
Their “good” intentions (or not) pave the way to our hell.
If you look at what they do instead of what they say, it’s clear that the Fed sees their mandate as:
To produce the maximum possible non-revolutionary wealth gap between America’s oligarchs and its masses.
The FED itself says:
Although the terms bank supervision and bank regulation are often used interchangeably,
they actually refer to distinct, but complementary, activities. Bank
supervision involves the monitoring, inspecting, and examining of banking
organizations to assess their condition and their compliance with relevant
laws and regulations. When a banking organization within the Federal
Reserve’s supervisory jurisdiction is found to be non-compliant or to have
other problems, the Federal Reserve may use its supervisory authority to
take formal or informal action to have the organization correct the problems.
“their compliance with relevant laws and regulations.”
Ouch, I hurt myself laughing….
Its hard not to conclude that either the FED didn’t know what the banks were/are doing, or refused to take any action that the banks did not want. To me, the FED is very much like the cops who don’t actually commit police abuse, but can never figure out if it occurs, never actually sees it, and can’t stop it.
But as much as I enjoy FED bashing, the bigger problem is that the entire world buys the notion that all “economic” problems (I don’t buy that inequality is an economic problem – it is a POLITICAL problem, and the very idea that one uses the FED to address it IS the problem) can be tuned to perfection by fiddling with the interest rates. Fiscal policy, tax policy, addressing inequality, etcetera are simply not subjects for polite discussion, because it is all FED all the time. The FED is a big McGuffin…
Yes. That’s why I say that the Fed is complicit in, the prime enabler of, Congress’s dereliction of duty: by their ‘heroic’ and unconventional efforts, the Fed fosters the belief that that monetary policy can solve all economic problems — a belief that makes only upward redistribution of wealth possible.
How convenient for our oligarchs.
Where is our Andrew Jackson?
Yeah! Rout ’em out! Andrew Jackson for President!
thanks for that!
Well said. One could say this applies to the federal govt as well.
Further, the Fed forgot the “non-revolutionary” part of its tacit mandate during the Great Depression, at a time when FDR and other elites were nervous about the influence of the (ore-Stallinist) USSR model on domestic labor. With the fall of USSR and the pitiful decline of US labor as a threat to the oligarchs, the Fed has much greater latitude to increase the inequality until the “non-revolutionary” contingency has to be reckoned with. With the consolidation of US media into five companies, political discourse has shifted so far to the right that when keeping things “non-revolutionary” finally becomes a consideration, the revolutionary threat will likely be a business-friendly right-wing revolution, i.e. the f-word that must not be spoken.
Thanks again for the great, succinct description.
The rate increase is a declaration of victory by bureaucrats for taking extraordinary measures that made a lot of things worse and a few things better. Getting off zero and making it stick, if only temporarily, means what they did was right because now we are back to “normal.” For musty-smelling fed bureaucrats, this is a gold metal win. All the debt on the balance sheet, all the giveaways to the big banks, and all the inequality they created can now be judged as worth it. High fives and chest bumps rule the day around the Fed table. Their legacy is now secure. Be happy for them. They needed this win and now they have it. Sore losers who grumble about their flat wages, unsustainable debt, deflation and their stripped-mined economy will never get a good sportsmanship award.
Interesting points. One point that I’m mostly not gonna buy is this below; I think the level on the 2yr, and 10yr, respectively, are instructive here.
“…projections of the expectations of the policy makers (not their plans, to be clear) show interest rates rising to between 2 and 3% by the time the new President…”
Who does these forecasts for the Fed … the National Association of Realtors? “Buy now, before interest rates go up!”
If the Fed cranked short rates to 2-3% while 10-year Treasuries stay put at 2.25%, what they would achieve is inverting the yield curve — a classic precursor of recession.
An inverted yield curve would just make it “too easy” to sell down some equity exposure. But a fairly flat yield curve would happen first.
I’m glad somebody here got that point about the 10-yr UST.
“Dean Baker of the Center for Economic Policy Research (CEPR) wrote almost immediately after the decision multiple reasons why DATA DO NOT SUPPORT A DECISION to raise rates…..”
Then what does support a decision? Answer, again from the post:
“Facing this pressure, Janet Yellen has most likely decided play a strategic game: give in to the demands from her colleagues for a move toward higher rates….
……. It seems like a long shot. Finance has its long knives drawn and it has plenty of allies on its side.”
It is a political tactic in response to the organized political opposition to job growth and potential wage growth and lobbyists biased for bank profits. Understanding the charts and graphs data sets will not yield a clear understanding of the economic decision made here and in other instances where there is a political consequence for every basis point, no matter what up or down direction rates go. Economics can not escape the gravitational pull of greed to endlessly seek profits under capitalism. Magnetar, good name, even better tell. And the power calculus of Harold Laswell: “Politics is who gets what, when and how.” Janet Yellen’s opposition, the Fed inflation hawks and their Wall St allies, will be back for more basis points. Can she mount a defense and gain allies from the NC community to restrain any more rate hikes for a prolonged basis, maybe after the next president is sworn in? I think it makes sense to support such a position.
Yellen appears to be trying to catch falling long knives.
With this extra drag an the economy, TPP should sail through the Congress. Speaking of coups…
I think Elizabeth Warren needs to call Yellen in for some hard questioning.
Why? How did a profitable policy become unprofitable?
Maybe Wall St is making fewer and smaller loans as fracking is crashing and the unicorn cycle has peaked, and there’s little other demand, and nothing close to the scale of Silicon Valley and oil. So how can Wall St make money? Get interest on the massive reserves it acquired when it sold off (at face value) underwater assets to the Fed after the crash.
Myself and many other commenters on this site have been saying for a while that zero rates were basically worthless. The low rates were meant to encourage investment in PP&E and consumption in order to spur the economy. Since the business sector doesn’t see the return on capital investments and workers are already saddled with as much debt they can handle, none of this has transpired. All the low rates have been doing is propping up asset prices by encouraging speculation. Indeed I’ve been following a several part series on the mismanagement of CALPERS–on this very site–which discusses their misadventures at chasing returns.
Wall Street is finally catching on and demanding what we’ve been lacking for almost a whole decade. A risk-free rate of return that actual matters. There are several things to gripe about. This is coming because Wall Street whined for it long enough. It will most assuredly help banks and finance firms more than the general public. Banks were already raising prime rates yesterday. Do you think they will raise savings and CD rates as well? I bet that part lags and even if they do go up, the spreads will be wider.
However, I still think this is the right thing to do. A return to normal rate levels will help pension funds return to more risk-free financial assets and steer clear of risky gambits. Eventually it will help the average saver (although not as much as the banks). As Warren Mosler often points out, interest income is income. Something this economy desperately needs. Definitely needs it more than it needs cheap credit.
The Fed’s justification for doing so is all wrong (the economy is getting better. haha, pull the other one), but in this case I think they’ve blindly stumbled into making the right decision.
Since the business sector doesn’t see the return on capital investments
I’ve been singing this same song for awhile but I am increasingly of the view that the bigger problem is that financial engineering is too profitable. Yes, lack of demand is a big problem. But overall crapification suggests plenty of opportunities to profit from offering decent products and services. But why do that when the profits from financial engineering are so much better and easier to achieve?
I pretty much agree.
But I think the bigger problem is not so much the profits, as it is the people at the top never have to fear a real loss.
If we are generous, I think we can interpret this as the Fed throwing in the towel. It’s not confidence in the American economy, but confidence that the Fed can’t help the American economy. They finally figured it out after years of pushing on the wet noodle.
edit: Agreed LiW. Free money incentivizes gambling not investment. A zero interest rate conflates debt with income.
I think you’ve hit the nail on the head, josh.
borrowing is not income
debt is not wealth
It is strange, or perhaps obvious to a plan to pauperize the population, that raising wages, or increasing employment, is the subject that dare not be discussed in the MSM…
Particularly appreciated both Yves’ Fed governance recommendation in the last paragraph of her intro and Mr Epstein’s fiscal policy recommendation in his final paragraph.
So the Fed-Treasury’s Great Financial Collapse rehab efforts post-2008 encompassed not only huge liquidity infusions into the financial system, but to quickly and significantly increase the banks’ net interest margin between their legacy mark-to-model “earning assets” and interest-bearing liabilities through negative real interest rates (NIRP) on their deposits and other liabilities, such as repo and loans from the Fed… in order “to foam the runway” for them.
However, as their higher yielding loans and securities were repaid, refinanced or repriced over the past 7 years, the banks’ net interest margins have subsequently been gradually reduced to the lowest level since 1985. So QE-NIRP has not only gradually lost its policy efficacy, but all the “free money” has led to rampant and widespread gaming of the system through corporate stock buybacks, increased corporate dividend payouts, huge Merger and Acquisitions volumes; and various loan, securities and derivatives speculations by the recidivists. This baby step increase in interest rates is intended to begin to gradually address these issues without upsetting anyone, perhaps most especially those in “Emerging Markets” who last I heard were trying to do an end run around Bucky and certain supranational institutions.
I’m shocked, of course… But as this is the Festivus Season I do want to share some good news for the Rest of Us: Free tees to commemorate the first Fed rate hike in like… Forevah! (I did hear they’re going fast):
Did anyone else listen to the extremely brief statement by Lagarde speaking for the IMF? She said the IMF is in agreement with the Fed’s decision to raise rates by 25 basis points… and then she said that any future raises must be data dependent on the inflation rate, and other actual data. Well duh. It was as subtle as the IMF could be about the Fed’s blatantly fake data. The IMF is not happy that the Fed tweaks the rate at the expense of EM countries. And Yellen, in her little speech, flipped a nickel Lagarde’s way because she actually mentioned international considerations, which mention she usually avoids. Interesting.
that’s why these people are famous. because they can hit the nail on the head
I don’t know about this post. It’s a bit wobbly. It doesn’t actually use equations outright, but you can feel them in the background sewing confusion and contumely. Those are two different things, in case anybody thinks I’m repeating myself.
At some point they just have to raise rates. Why wait another 7 years? Why not now? Let’s just get on with it already and find some other reason why the economy has an “output gap”. That’s like a big pile of output and an imaginary pile that’s even bigger than the real pile, and the difference, if you imagine this in your mind like a mountain with a bigger mountain lightly superimposed over it in a translucent shading and the difference between the outline of the real mountain and the translucent superimposed mountain — if you did an integration of the relative space between the two curves using calculus — you could measure the out put gap. An 18 year old kid at college could do this. Don’t be intimidated. The hard part would be figuring out why you’re doing it — but if you’re at the point where you’re trying you never will.
As Lambert says, when someone says “the economy,” ask yourself, “Whose economy?”. Likewise, when someone says ” the recovery,” ask yourself, “Whose recovery?”
Here’s how things are for us regular Joes:
I have an adjustable rate mortgage that Wells Fargo regrets they ever wrote. My rate has been as low as 2.5% while FED rates have been zero. I don’t make much so the low rate has allowed me to hold on to my house (I have some equity). My annual review at work is today and I expect to receive a 1% to 3% “raise,” and of course “no one gets 3%”. Essentially a cost of living adjustment that is less than the increase in my actual cost of living, same as I have been getting since I started there 4 yrs ago. I pay less at the pump, but that doesn’t offset the increased share of health insurance costs I pay at work, the increased cost of filling my refrigerator every month, or the increase I anticipate in my mortgage payment. Of course any savings were gone long ago and I have student loans and credit cards I can’t get ahead of. My brother in law just got laid off from his construction job and my sister, who lost her career in 2008, has a $10/hr job and can’t find anything better. Emphasis on “career.”
Everyone we know has a similar story. I’m sure that, in addition to my mortgage rate, my credit card rates will increase as well, while my pay continues to decrease in real terms, and I doubt a rate increase will assist with my biggest budget items such as food and insurance. So well done to Janet on another giveaway to Big Finance. Way to slow – I mean, Way to go! Looks like 2016 is gonna be another rough year.
And the same goes for all of us Regular Janes out there too. Thanks, Observer.
I think there are many tens of millions of us out there who are asking “what recovery?” And by the way, in my 35-year working career, thanks to Ronnie Reagan’s Revolution, my “raises” have never, ever kept up with my increase in living costs. Got used to that a long time ago, hon.
Thanks for the example.
You know, you don’t have to be a rocket scientist to be able to put together your examples, and see the non-stop bullsh*t about how good the economy is doing.
I tell you, it seems sometimes the dissembling about economic circumstances is even worse than the economic circumstances. If they are too stupid to fix it, that is one thing. But if they are lying and trying to screw us, that is just a whole other kettle of fish….and its hard for me to believe that they are not trying to screw us….
This is a remarkably clear article, well presented with a sharp introduction by Yves. Many thanks and I will indeed be sending the link to friends.
Will this put a break on real estate sales if only by assumption of future rate increases? Perhaps the mortgage servicing companies are ready for another round of court facilitated ethics deprived morally depraved robo-signing and throwing families out onto the streets as part of a juicy forclosure and penalty profits initiative, version II: No Families Left Behind..
Free the Profits!…confine the people.
Multinational Monetary Mayhem …evidence global societal acrimony
Yves, thanks for this explaining why Yellen raised interest rates.
When I saw the stock market go up immediately after the FED raised their rate, I asked why since it was counter-intuitive. Pam Martens answered that this morning.
My next question is how are the large corps going to handle the increased costs of the debt they have put on their balance sheets as they bought huge amounts of their own shares for the last 5 years to keep the party going. Won’t this hurt employment? What am I missing here?
Also, is corp debt where wall street banks going to make new money?
Outstanding article and outstanding comments.
Regarding Epstein’s final paragraph about fiscal policy, Yellen can’t directly do anything about this, right? Who might her “allies” be who can engage in “much more creative, direct job promotion and direct promotion of local infrastructure investment”?
To what people or structures might we apply pressure to encourage action in this direction?
Regarding Yves’ recommendations for improvements in Fed governance, starting with how regional Fed presidents are selected and approved–who’s in a position to influence this, and how can we support this idea?
this article is mistaken.
rates should have been raised in 2011.
The only reason for keeping them on a 7 year emergency has been the “wealth effect” – a transfer of assets from the middle class to the uber wealthy, private equity and so on who are back stopped by the Fed. The beneficiaries have choice praises for bernanke – “bold”, “decisiive”, “courageous”…. ie. ” thank you so much”, and bernanke did get himself a job at one of these joints he benefited.