One Man’s Opinion: Will The Federal Reserve Keep Rates Low To Boost Consumption?

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92835431Following the Fed’s two-day monetary policy meeting this week, Chairwoman Janet Yellen said the central bank is going to stay accommodative for a long time after it ended its monthly bond-buying program this year, reassuring markets a rate hike is not likely any time soon, said Vincent Reinhart, chief US economist at Morgan Stanley.

Asked if Morgan Stanley agrees with Fed vice-chair Stanley Fischer, New York Fed chief William Dudley etc that the US central bank should push ahead with current policies and not change course, Vince said the Fed is going to keep rates low for a very long time. It’s conventional macro wisdom. There’s still resource slack in the economy; inflation is picking up, but it’s still below the Fed’s target of 2 percent. So, policymakers have still got some room to run, he noted.

Noted economists like Milton Friedman, Ben Bernanke and Richard Timberlake have all said central banks are always behind the curve. Asked if Janet Yellen fell short of expectations this week, Vince said policy rate in every country is asymmetric. It goes up a lot more slowly than it goes down because policy tightening is done in a planned fashion.

Policy makers like to start a little late and go slow because they want to ensure growth has gathered momentum and is sustainable. They don’t worry about an early rise in wages and costs because that’s good news. Higher wages create more disposable income, making the consumption gain more widespread.

Also, inflation isn’t such a bad thing, particularly if it remains below target. Fed officials are increasingly trying to tell the markets that the 2 percent inflation target is a goal, not a ceiling, which means it can either overshoot or undershoot the target, he observed.

The latest CPI reading came in at 2.1 percent earlier this week. Asked if that indicated things are working fine and rates need to be reconsidered, Vince said Janet Yellen characterized the latest inflation data as noise. Three months change above goal is worrisome, but Fed officials in their April meeting pointed out there were temporary factors (that were) tending to drag inflation down, but they were beginning to fade. If the Fed’s forecasts were beginning to come true, that shouldn’t be a reason to change the forecast, he argued.

Asked if investors should worry about inflated asset prices and bubbles forming in certain sectors, Vince said there are pockets of froth, because that’s how the monetary transmission policy works. If aggregate demand is weak, central banks keep rates low and encourage risk taking to support asset prices, he explained.

Asked if the Fed should immediately raise interest rates just to signal return to normality, as suggested by some economists, Vince said a lot of investors who were encouraged by the Fed to take risks will liquidate their positions, which will create a lot of distress in the markets. Just the talk of curbing asset purchases last May were enough to blow-out spreads wide and volatility higher, he concluded.

You can watch the video here.

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