Policymakers are in the midst of contemplating how to respond properly to pressing economic problems as the entire market is carefully on its guard. One of the main concerns today is whether the Federal Reserve will implement a rate hike this month or hold off for a few more months. It's also probably wondering, “WHY should we opt for a rate hike?”
There are many things that the Fed needs to take into consideration. The US central bank has to determine which theories to strongly embrace, how important economic growth and financial stability are and what it is willing to do to sustain it, how important inflation is and how the markets will be affected by future decisions. The Fed is also likely to look at how other global economic events like China’s downturn and Greece’s financial crisis will carry through.
The amount of things that the Fed has to pay attention to seems to complicate everything. In terms of macroeconomic theories, it is believed for years that increased interest rates will pull the economy down and weaken inflation. On the other hand, flat interest rates give rise to economic growth and strengthen inflation. This is a belief contradicted by the Neo-Fisherism theory, which says that increasing interest rates will eventually lift inflation. The theory may seem impossible, but it's now gaining the confidence of investors and analysts as the economy goes along with modernization. Investors biting at the theory can also be attributed to US and Japan’s failure to counter-attack economic slowdown with their quantitative easing programs.
With the rise of various and opposing theories, it is undeniable that no policy maker understands fully how monetary policy works. On that note, we can interpret why Fed officials sound confused and skeptical — until now — on a proposed rate hike and its timely implementation.
In the recent symposium of top central-bank policymakers held at Jackson Hole, Wyoming, Fed Vice Chairman Stanley Fischer expressed immense uncertainty on numerous topics. His statements did not imply affinity for a rate hike while recognizing that inflation is below the central bank’s target of 2 percent. Fischer added that untapped labor resources hinder inflation as well.
However, he claims that what the Fed seeks is to normalize interest rates. Fischer said, “We will most likely need to proceed cautiously in normalizing the stance of monetary policy. With inflation low, we can probably remove accommodation at a gradual pace.”
Normalization Fascination
The Fed points out how normalization of rates is its primary objective. Here's why: the US central bank is trying to manage expectations. If people become too acquainted with zero interest rates, the economy could hit rock bottom when Fed finally implements a rate hike. Along with this, the Fed is also looking at normalizing monetary policy to maintain financial stability as the Neo-Fisherism theory becomes a consideration.
However, the Fed’s dilemma is not indecisiveness. It is a lack of knowledge on what is causing the entire boat to sink. Honestly, the Fed might be taking its history lessons as they refer to records that include periods when interest rates were higher — a move that is masked as ‘normalization’.