Why Is The Fed Raising Interest Rates As Fast As It Is?

Yves here. In a bit of synchronicity, this post confirms the theory I’ve had for a while as to why the Fed looks overly eager to raise interest rates. I’ve heard some intel from people who are plugged in, but it’s interesting to see others come to the same view using Occam’s Razor-type processes.

But there is always the possibility that the Fed believes its own PR, and has gotten anchored in the New Normal, and so thinks a little better than the (very crappy) New Normal amounts to too much groaf. Or perhaps they’ve taken notice of the asset bubbles and decided they need to take some air out of them, even if it might not be so hot for the real economy.

By Barkley Rosser. Originally published at EconoSpeak

I have a theory that at least some people at the Fed are supporting interest rate increases not because they are worried about incipient inflation that must be nipped in the bud in advance under a regime of inflation targeting, but because they are looking over the horizon and worrying about a possible recession in the not-too-distant future, and they want to be able to have interest rates high enough that they can then engage in lowering them as a stimulative policy tool under the circumstances.  If they are too low, then extraordinary measures will need to be used, and some of those measures may not be available in the future.

This theory is based on nothing solid at all, nothing.  I think that those who may be thinking this (and my likely candidate(s) would be people at the very top) are constrained in speaking openly due both to the current institutional arrangement of consensus decisionmaking within an established inflation targeting system with a 2% inflation target, not to mention pressure not to talk about possible future dangers.  The current line is that the economy is doing well, and certainly it is on the standard measures of unemployment and inflation, even if the former could be better and wages could be rising more rapidly.  Indeed, it is this good performance that is supposedly underlying the moves to raise interest rates and possibly “normalize” the balance sheet (which I doubt there will be too much action on).  But my theory is that for some of them it is a matter of trying to “normalize” on interest rates as well while the possibility of normalizing is possible, while the economy is doing fairly well and one can raise them without obviously slowing things down noticeably, so that indeed there will be the ability to lower them again in the future when necessary.

He did not put this theory forward, but it was reading the recent column by Larry Summers that appeared in the Washington Post on Monday was been linked to by Mark Thoma today (unable to make that link, sorry) and also can be gotten to at larrysummers.com/2017/08/14/why-the-federal-reserves-job-will-get-harder.  He is focused on the upcoming ending of the term of his rival as Chair of the Fed, Janet Yellen, and is worried about who Trump will pick and what will happen.  While stating that he would have “preferred a slower pace of interest rate adjustment,” he bottom lines that “Overall it has done well in recent years” (even though he did not get picked to be Chair).

While he thinks the economy is currently doing pretty well, looking forward he worries tha it is “brittle” with numerous dangers, and opines that there is a two thirds chance of a recession during the next Fed Chair’s term.  He then notes how the still low interest rates will make it hard to use the interest rate tool to stimulate the economy, making it difficult for the Fed to do much.  He does not make the leap I did to the possibility that this fact may be on the minds of at least some people at the Fed, although they really cannot openly say it.

I agree with his concerns about what is coming due to the political situation, with “major risk now of presidential interference” in the Fed, and he makes disparaging remarks about the president quite reasonably so.  He also notes that the “temper of the times has turned against technical expertise in favor of populist passion.” There is reason to be concerned about what he will do.

But in the meantime some people at the Fed may be doing their best to make it possible for the Fed to do something in the future when the need will surely arise.

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38 comments

  1. Praedor

    Leave the rates low and use helicoptor money TO THE PEOPLE instead of banks next time. Boom! Instant economic stimulus from the bottom up, like all REAL growth.

    1. nonsense factory

      What about people’s savings accounts? Raise the rates and people can earn some interest on savings, particularly in the credit union & commercial banking sector that services the home loan and car loan and small business loan world.

      As far as a stimulus from the bottom up, New Deal style programs for infrastructure construction and a transfer of all fossil fuel subisidies to the renewable energy manufacturing, installation and finance sector would be the best bottom-up economic stimulus.

      Then, reinstate Glass-Steagall to isolate the casino banking sector from the commercial banking sector. And throw the heads of all the big investment banks in jail for their many crimes, from Goldman Sachs to JP Morgan to Well Fargo to HSBC.

      1. justanotherprogressive

        The problem is that the financial institutions that govern our country do not want you to save. To them, that is just “dead money”. They’d much prefer it if you spent that money and went into debt because their “economics” is dependent on managing debt……I remember reading an article about how the Chinese government and banks were so upset because so many of the Chinese were still hoarding money in their mattresses…..

        I would love to see Glass-Steagall reintroduced, but I won’t hold my breath…..

        As for infrastructure spending, well, that may be a possibility ….depends upon how “stimulating” it is for the financial sector…..and I don’t think they’ve made up their minds about that yet….

        1. Vatch

          I would love to see Glass-Steagall reintroduced, but I won’t hold my breath

          I agree with both clauses. It would be great, but it’s not likely in the current Congress. For those who don’t mind spending a few minutes encouraging good behavior, here’s information about the relevant bills before the House and Senate:

          H.R.790 – Return to Prudent Banking Act of 2017

          H.R.2585 – 21st Century Glass-Steagall Act of 2017

          S.881 – 21st Century Glass-Steagall Act of 2017

          You can contact your Representative here, and your Senators here.

      2. ben

        Which will instantly result in housing / rent inflation, all to be soaked up by rentiers and back to square one.

      3. nonclassical

        …likely wasn’t “end of Glass-Steagal” that allowed many steps of Wall Street “control accounting fraud”…though Texas republican senator Phil Gramm’s wife Wendy earned seat on board of ENRON for his instituting replacement “Gramm-Leach-Bliley Act” (all republicans). It was Texas republican senator Phil Gramm evisceration of portions of commodities futures legislation: (at this point libertarian propagandists commence scapegoating clinton for having signed end result, though concealed in omnibus bill…)

        Phil Gramm

        “As chairman of the Senate Banking Committee from 1995 through 2000, Gramm was Washington’s most prominent and outspoken champion of financial deregulation. He played a leading role in writing and pushing through Congress the 1999 repeal of the Depression-era Glass-Steagall Act, which separated commercial banks from Wall Street. He also inserted a key provision into the 2000 Commodity Futures Modernization Act that exempted over-the-counter derivatives like credit-default swaps from regulation by the Commodity Futures Trading Commission. Credit-default swaps took down AIG, which has cost the U.S. $150 billion thus far.”

  2. Anonymoose

    A republican held congress is one factor why they the Fed would believe that they need high interest rates as a tool to tackle any recession. Republicans are unlikely to do the fiscal stimulus necessary, leaving only monetary options.

  3. Bam_Man

    Of course The Fed is worried about going into the next recession (which is likely to be a real doozie, given debt levels in every sector) with benchmark interest rates still at what used to be considered “crisis levels”.
    Implementing negative interest rates in the next crisis would likely be highly problematic for the US, since its current account deficit is almost half-a-trillion dollars each and every year. Financing that deficit at negative rates of interest may just be too obvious a form of plunder for some of our international “partners” to stomach.
    And then there is the stock market bubble, floating atop a record level of margin debt.
    And then there are the unfunded pension liabilities of every municipal and state government, getting worse by the year due to insufficient fixed income yields.
    Plenty of good reasons for the Fed to be in a hurry to “normalize” rates.

    1. justanotherprogressive

      It kind of makes you wonder what instruments they would use to save the banks if they can’t raise the interest rates fast enough…..

  4. Dita

    I suggested something to this effect on Mish and he totally shot me down lol. And it is speculation of course, but given our recent history…

    1. Mark P.

      If the likes of Kenneth Rogoff are out there pushing negative interest rate policy again, there’s a reason and it’s what you’d expect. There will be another bust — there’s nothing speculative about that — and central banks are going to have no space to maneuver at all unless they can get interest rates up a little now.

  5. L

    To some extent I lean towards the idea that they are noticing the bubbles. China has recently been cracking down hard on the “grey rhinos” much to the plaudience of the economic press. I suspect that some of the recent debt-fueled buyback boom has created some similar, albeit unacknowledged, problems here and they may be more concerned with stemming that than with actual growth. This is just speculation of course but it would be in line with the FEDs usual habit of treating the happiness of big financial firms ans synonymous with a healthy economy employment be damned.

    1. Grumpy Engineer

      Oh, yes. I suspect that they’re worried about both stock market and housing bubbles, at a minimum. There also seems to be some belated realization that super-low interest rates have contributed to an accelerated growth in income inequality:

      https://www.nakedcapitalism.com/2012/04/growth-of-income-inequality-is-worse-under-obama-than-bush.html

      http://www.newsweek.com/2013/12/13/two-numbers-rich-are-getting-richer-faster-244922.html

      https://www.washingtonpost.com/opinions/charles-lane-the-feds-interest-rate-policy-may-have-fed-income-inequality/2014/09/17/6f1a4f5e-3e90-11e4-9587-5dafd96295f0_story.html

      It’s really easy to make money when interest rates are routinely lower than asset appreciation rates. The strategy of “borrow money, buy asset, wait for asset to appreciate, sell asset, pay off loan, keep profit” works quite well when interest costs don’t consume all your capital gains. And, of course, the strategy works even better when you’re already rich and have access to enormous credit lines at premium interest rates. If you’re poor, though, you don’t even get to play the leveraged asset appreciation game. Nobody will lend you the money.

      1. a different chris

        Bingo – nobody will lend the lower classes money to invest in themselves, and the lower classes* can’t put any money they save into anything that seems worthwhile.

        So what good are low Fed rates to the people that actually need help?

        *A number that is breaching 50% of the population, to me

  6. flora

    “worrying about a possible recession in the not-too-distant future…”

    I dislike that particular framing by so many in the elite financial community.
    Overlooks the fact that for 80% of the country the last recession is still very much with us. It’s never ended.

    1. flora

      aside: Interest rates and monetary policy can be used to combat recession. Fiscal policy can be used, too, except the govt seems unwilling to use fiscal stimulus. Why does the govt try to fight recession with one arm tied behind its back?

      1. PH

        Effective propaganda about the national debt and resentments about Government “hand-outs” and Federal taxes have intimidated Dems to the point that they do not dare even mention purposeful deficits. Instead, pols are convinced that the popular mantra is to reduce taxes and balance the budget.

        While increasing defense spending, and not touching popular spending programs, of course.

        Lunacy. But no one trusts the public to support a more rational approach.

  7. Catullus

    One possiblity…

    It’s Bitcoin and Ethereum that is forcing the Fed to raise rates. In a sense, BTC & ETH’s meteoric rise can be said to signify the massive loss of faith in the USD (US Dollar). Many times when I look at BTC or ETH soaring, I wonder if they’re in a bubble or is it the dollar bubble deflating? In the past, I would decide more decisively but these days, I’m not sure. It is definely a possiblity that the USD is now dying fast and the way to see it is to look at BTC or ETH quoted in dollars. If that possiblity is correct, then unpleasantly exciting days are in store for us all.

    All of the printing, malpractice and the frauds has to result in some real consquences that is mostly unseen at this point. I have seen minimal consequences other than soaring real estate prices in cities that may be deflating right now and yes, soaring healthcare costs (still rising tho some say its moderating.). One real consquence is lack of faith in the currency itself because the authority behind it is no longer acting in your interest – they are acting against your interests. That may be happening.

    The Fed is a middleman in many senses. BTC, ETH, et al removes them. So… in order to keep the value and usablity of the USD going… Raise rates! Higher interest rates can keep people in the USD longer because everybody loves some interest earnings…

    It doesn’t matter if the economy crashes – I don’t really see any signs the Fed cares about the people, really. The rich is rich enough to survive a crash while the masses… no. It may be a way to buy assets on the cheap, too.

    Sorry if I seem a bit weird or paranoid or a bit “out there” but these days, you really must factor in Bitcoin, Ethereum, et al. They may be in a bubble right now but they are NOT going away.

    Just offering a different persceptive that I’m sure many will laugh at but need to consider because life does send some strange curveballs time to time. Thanks for reading this.

  8. a different chris

    If you want to stimulate the economy, have the Fed buy out all the outstanding student debt from the banks and drop it to 0% interest. Simultaneously bump the Fed rate to 3%… now you have re-created the consumer base of the young and the savings base of the middle aged and old.

    And the Wall Streed f*cks can go back to playing with each other’s money and leave the workers out of it…

    1. ben

      this is the crux of the problem: wall street does not allocate resources well, instead they back rentiers, and workers are carrying themselves and the idle rentiers.

      Until that ends living standards will *not* improve.

      1. nonclassical

        …and, Wall Street continues speculation-manipulating-insider trading commodities, to everyone’s disadvantage…traveling abroad, we see how much more expensive is food, U.S.

  9. cnchal

    . . . the “temper of the times has turned against technical expertise in favor of populist passion.”

    The temper of these times was forged when Larry had his throne at the policy table two decades ago. All Larry ever wanted was one more lever to pull or dial to crank on the money machine and look where it got him.

    Let’s talk productivity. Larry was paid millions and destroyed billions, a ratio of at least for every dollar paid to Larry, he destroyed a thousand. One would think that Larry would be lucky to find a home living in a cardboard box under a bridge, but no, here he is being quoted as a guru while still raking in millions.

    1. nonclassical

      …Brooksley Born defined $690 trillion (nominal)…this documentation shows where resides today:

      https://www.thenation.com/article/why-fdic-insuring-jamie-dimons-mistakes/

      “JPMorgan Chase shrewdly parks virtually all of its vast derivatives holdings in its commercial bank subsidiary. In the event of a collapse, the bank can use its deposit base to pay off the derivatives, while leaving the Federal Deposit Insurance Corporation to reimburse depositors if their money runs out. This is not a trivial technicality. JPM is the world’s largest purveyor of derivatives. Its total contracts have a notional value of $72 trillion—and 99 percent of them are booked at its FDIC-insured bank. In the event of failure, sorting out the claims and counterclaims will be a costly nightmare for the FDIC. The bulk of the contracts are “plain vanilla” derivatives used as standard hedges against price or currency changes. The exotic derivatives, however, are dangerous—the kind that suddenly blew up in Dimon’s face some weeks ago, when his bank swiftly lost at least $3 billion on one complicated market gambit, with maybe more losses to come.

      We are “insuring” other big boys of banking in the same way. Citigroup has nearly all of its $53 trillion in derivatives in its FDIC-insured bank; Goldman Sachs has $44 trillion parked at an FDIC-backed institution. After Bank of America purchased Merrill Lynch, BofA began transferring the securities firm’s derivatives to the FDIC-insured bank, which now holds $47 trillion in contracts. When Senators Sherrod Brown and Carl Levin, among others, complained that regulators’ acquiescence in these transfers contradicted Congressional instructions in the 2010 Dodd-Frank reform law, the Federal Reserve, the FDIC and the Treasury Department’s Office of the Comptroller of the Currency refused to answer their objections. This matter involves “confidential supervisory” and “proprietary business information,” the three agencies responded in unison.”

  10. Hiho

    My theory is that the fed has given enough time to insiders and friends to sell their assets and now it is time to restart the game.

  11. philbq

    The recently released Fed minutes revealed a split on the Fed board: the moderate members noted that inflation is well below 2 percent, thus no need to raise rates. But the hardnoses on the board whined about ” the economy has reached full employment, and might cause inflation”- this is saying that workers getting a raise is bad for the economy…WTF??? Firstly, the economy is NOT at full employment- just look at the huge crowds lining up for $12 Amazon warehouse jobs. Secondly, since 70% of the U.S. economy is consumer spending, it is good when workers have spendable income. But this clearly shows that the Fed never worries about stock market bubbles, but hates workers getting a raise. In other words, the Fed works for Wall St., not Main St.

    1. ben

      The entire point of the system is using fiat money to extract actual labour and resources. Wage inflation kills all that.

  12. Chauncey Gardiner

    Fed officials’ expressions of desire and intent to materially raise interest rates have been voiced by senior Fed officials since at least 2012, and are typically about a hypothetical time that is a year of two in the future. In the meantime, the reality is that nominal rates remain at very low levels and are negative in real terms for maturities less than about 5 years, although rates have risen slightly this year in maturities out to about three years.

    https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

    I think a bigger issue for the Fed is how flat the Treasury yield curve is, as many banks make their bones by borrowing short-term and lending or investing long-term. Hence the possibility this is in part behind resurrection of the negative interest rates proposal discussed elsewhere here at NC today, although I suspect declining loan demand and rising loan payment problems together with the sensitivity of financial markets to rising interest rates may also be playing a role.

  13. djrichard

    Since Aug 3rd, the 13 week treasury yield is in decline. See ^IRX (on Yahoo finance). This suggests the rate hike regime is on pause for the moment.

    The Fed Reserve Fed funds rate tracks with the 13 week treasury, always following that rate. It’s interesting to watch what happens to the 13 week treasury when there’s yaw-boning by a Fed Reserve member. It definitely reacts to their jaw-boning, not all the time, but there are definite times you can see it. So it’s hard to know if the Fed Funds rate is merely following the 13 week treasury. Or if the 13 week treasury is anticipating the Fed Funds rate.

    1. djrichard

      P.S. Looking again at the 13 week yield, it’s actually just about where it was when the Fed Reserve did its last rate increase on June 14th. If the 13 week drops by say 20 more basis points, the Fed Reserve will be forced to drop their Fed Funds rate. Because otherwise, their rate would be too expensive which would drain liquidity.

  14. JeffC

    YOU have a theory?? You and half the financial universe. Many, many pixels have flickered in the financial press for several years about this theory. Haven’t seen much on it lately, but I assume that’s because it’s old news. It’s so much a part of the general atmosphere now that it hardy bears discussion.

  15. MG

    The Fed has reduced interest rates by an average of 5.5 points during each recession since the end of WW2. Given how bloated the Fed balance sheet is, their primary monetary tool would be creating negative interest rates.

    It has been getting pushed hard by Rogoff and there was an article on Monday about it on Bloomberg:

    https://www.bloomberg.com/news/articles/2017-08-14/central-banks-told-to-embrace-negative-rates-as-recession-looms

    Goodfriend, an almost surefire lock to get nominated to the Federal Reserve Board of Governors, has also been supportive of the idea of negative interest rates.

    Trump is going to have a historic opportunity to potentially place up to 6 nominations on the Federal Reserve Board of Governors in the next year too including replacing Yellen. No President has remotely had that much influence on the Federal Reserve Board of Governors in such a short time. It is an incredibly important topic that even the more seasoned financial reporters are ignoring.

  16. DSB

    It is just as plausible that someone at the Fed remembered that the interest rate cuts to the zero bound represented an “emergency response” to the Great Recession / Great Financial Crisis. Forgetting that, the Federal Reserve left interest rates at “emergency” levels for over 7 years and I would argue a Fed Funds Targeted Effective rate of 1.15% constitutes an emergency level still. After all, real interest rates remain negative today. The last time the effective rate was 1.15% was 9 years ago, the time before that was 13 years ago. Besides these two times interest rates have only been this low two other times in the past 60 years – 56 and 59 years ago.

    Gee whiz, “fast” isn’t even close. They should have taken rates off the emergency level in the fall of 2010.

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