News Column

Short-Term Rates Should Be Raised Steadily - Fed's George

July 15, 2014

WASHINGTON (Alliance News) - A gradual increase in short-term interest rates will serve the economy well, Esther George, President of the Federal Reserve Bank of Kansas City, said Wednesday.

The economy has been steadily improving post the crisis in the past five years, however, the rate of recovery still remains weak, she said.

Though the labor market is optimistic and new job creations are increasing, the more than expected inflation rates, particularly inflation in food prices and rents, puts a strain on the low-income households in the face of nominal wages.

On the Federal Reserve's asset purchases policy and zero short-term nominal rate, she said, "getting interest rates off zero relatively soon is not only appropriate in terms of current economic conditions, but also will allow the Fed room to maneuver in the future should economic activity slow"

As asset purchases come to an end, the short-term rate should be increased to a more nominal level as this is preferable rather than intervening in longer-term Treasury or mortgage markets. Moreover, todays' economy with strengthening labor market and rising inflation is ready for such measure, she said.

"Furthermore, waiting too long may allow certain risks to build that if realized, could harm economic activity without room to adjust rates in response" she added.

Though pessimists may argue that the economy is not strong enough to begin moving to a more nominal-rate environment, moving rates up will aid price stabilization in the long run and also send a clear message that the Fed sees the economy as finally moving past the damage inflicted by the crisis.

Speaking on the specific measures to control short-term rates, she said the the two basic principles would be to return to a Treasury-only portfolio and to return to a policy framework of influencing short-term rates instead of the balance-sheet policy.

Regarding the challenges that might crop up with the suggested policies, she said, "One possible bump could be a reemergence of volatility in financial markets"

"Should financial market volatility increase, some may argue the FOMC should slow or even reverse any steps taken in the normalization process. While policy needs to respond to incoming data, adjusting policy to bursts in financial market volatility or in response to temporarily soft data needs to be done with caution as stop-start policy reactions have historically produced poor economic outcomes. As a result, I see the economy as best served by steadiness during the normalization process" she added.

The transition to a more sustainable policy will avoid the set of problems that may arise by waiting too long, she said.

"A steady path toward raising short-term interest rates, similar to how the Fed has approached the reduction in asset purchases,will serve the economy well" she concluded.

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Source: Alliance News

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