Fed Interest Rate Policy – Rate Hike Needed NOW!
The Federal Reserve has played more of a position in this recession than any in history, acting first to drop rates to questionably low levels while quantitatively easing the credit markets to the tune of more than $1.5 trillion. Undoubtedly, today’s low overnight rate of .25% will not be around forever, and now the pressure is on to push rates higher.
Rates Must Rise
During recessions the central bank adds money to the money supply to quell rate hikes. This time around, rates were dumped to a RECORD low of .25%, crushing the previous bottom of 1% that was made after the credit crunch. But the Fed now has a history to avoid. Last time rates hit 1% a real estate bubble emerged, and this time, with stocks up more than 50% in 5 months, it looks like we may have another asset bubble on our hands.
Why Raise Rates
Monetary policy isn’t entirely dictated by the Fed. Granted, the Fed has more power than any other agency, however, Congress also has a huge impact by adding or subtracting money by increasing or cutting spending. If Congress were to run a surplus (yeah right) the amount of money in the supply would dip, as taxes would be used to pay down debts. Right now, we’re running a massive fiscal deficit, which can only mean we’ll add money to the supply.
Raise Rates, Curb Inflation
Rates have now been at historical lows for more than two quarters, which typically brings out widescale inflation. Luckily, consumers as a whole have been removing debt from their personal finances rather than adding it. When better times come, consumers will be more interested in borrowing and in effect add money to the money supply.
Stimulus Package and Rates
Its not just rates we have to worry about. The stimulus package, which so far has done very little, with only 9% of it spent, is set to rocket government spending next year. A full $350 Billion is set to be spent next year alone, in an economy of $14 Trillion, that is a direct 2.5% of GDP. Considering that money will make its way through GDP calculations a few times over, the least we can expect is pure and simple monetary inflation if the Fed does not hike interest rates.
This whole stock market surge has been Fed induced. I don’t believe it will last. Consumers are not spending right now, and the Fed can’t keep pumping forever. I think the powerful forces of deflation will eventually win over as they have with housing and wages. The banks will make money on successful loans with a .25 fed fund rate and market investments, but they will lose their shirts on defaults from even prime borrowers and commercial loans. I believe it’s time to get scared.