U.S. Federal Reserve betting it will avoid central banks' past errors

LONDON -- The Federal Reserve is poised to raise interest rates Wednesday for the first time in 9 1/2 years.

See Full Article

It may not take so long to know whether its decision was correct.

History is filled with cases, from the Fed in the 1930s to the European Central Bank in 2011, when central banks raised rates prematurely, sometimes with dire consequences. Raising rates or otherwise tightening credit too soon can slow borrowing, jolt confidence and choke growth.

When the global financial system started buckling in 2007, central banks cut rates to fight the worst economic catastrophe since the 1930s. As the crisis escalated in late 2008, many rates were slashed to record lows. The Fed cut its benchmark rate to near zero.

Mindful of the risks of higher rates and of the U.S. economy's lingering weaknesses, some economists have suggested that the Fed could wait a bit longer before raising rates, especially with inflation still low amid slumping oil and commodity prices. In a survey of top academic economists, the University of Chicago found that while 48 per centfavoured a rate hike, 36 per cent felt the Fed should hold off.

Andrew Levin of Dartmouth College is among those who think the Fed is acting too soon.

"The economy is not that close to normal yet," Levin says. "Inflation has been persistently falling short of the Fed's target."

Levin notes, too, that while the unemployment rate is a low 5 per cent, millions without jobs have given up looking for one. Levin says employers would have to add 200,000 jobs a month for at least another year to restore the job market's health.

For any central bank, the hardest task is to continually straddle a delicate balance:

Keeping rates too low for too long can inflate asset bubbles as investors seek returns that are higher -- but riskier -- than returns on government debt. Low rates can also weaken the ability of central banks to combat a new crisis or recession.

But equally, central bankers must take care not to increase rates too soon. Since the global financial crisis, several central banks, from Israel's to New Zealand's, have raised rates only to have to reverse course soon after.

Chair Janet Yellen summed it up in a speech Dec. 2. Yellen said delaying a first increase too long might later compel the Fed to raise rates faster than it would like.

"An abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession," she said. "Holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability."

Here are some examples when history suggests central banks should have waited longer to tighten credit.

THE FED's 1937 ERROR

In 1936-37, during the Great Depression era, the Fed sought to normalize its policies by increasing the amount of money banks had to hold as reserves. Many blame that decision, along with a tougher budgetary stance from the U.S. government, for helping prolong the Depression. The economy fell back into a brutal recession in which around 2.5 million Americans lost jobs.

By 1938, President Franklin Roosevelt reverted back to the expansionist policies associated with the New Deal that he had been implementing since 1933. And the Fed rescinded the increased reserve requirement. The economy then enjoyed a spectacular recovery, helped by wartime spending.

In a 2012 speech, Charles Evans, head of the Federal Reserve Bank of Chicago, warned of a "natural tendency" for policymakers to want to undo super-low rates.

"Such errors happened in 1937 when the Fed prematurely withdrew accommodation," Evans noted.

JAPAN'S LOST DECADES

Ben Bernanke, the Fed chairman during the 2008 crisis, was a keen student of Japan's experience after the bursting of a stock and housing bubble in 1990. A quarter-century later, Japan still confronts the repercussions of that shock, notably deflation, or falling prices.

In August 2000, barely a year after the Bank of Japan adopted a zero rate policy, it raised rates for the first time in a decade. It justified that move by noting that confidence was returning and prices were rising. But a few months later, the central bank was compelled to cut rates again as Japan's economy slid back into recession and prices fell again.

Japan's experience reflects the risks of raising rates when inflation is negligible, as it now is in the United States.

EUROPE'S DUBIOUS HIKES

The European Central Bank, which sets rates for the 19 countries that use the euro, is enacting a huge stimulus program intended to ease borrowing rates. The ECB's program marks a sharp policy reversal. In 2011, the ECB raised rates twice, boosting its benchmark rate to 1.50 per cent. The bank, then led by Jean-Claude Trichet, said it needed to reduce inflation pressures in the eurozone.

By year's end, the ECB, now led by Mario Draghi, changed course as the rate hikes and export-sapping appreciation of the euro pushed the economy back into recession. The region was also fighting a debt crisis that threatened the euro itself.

Critics regard the 2011 rate increases as a major policy mistake.

Paul Wiseman contributed to this report from Washington.



Advertisements

Latest Economic News

  • Asian stocks mixed after U.S. federal reserve boosts Wall Street

    Economic CTV News
    BANGKOK - Shares were mixed in Asia on Thursday after U.S. stocks reversed early losses and finished higher as investors appraised the Federal Reserve's signal that it is not in a hurry to raise interest rates. Source
  • Federal government blocks sale of construction giant Aecon to Chinese interests

    Economic CBC News
    The federal government has blocked the sale of Canadian construction company Aecon Group Inc. to Chinese interests, the office of Innovation Minister Navdeep Bains has confirmed. The controversial deal between Aecon and China's CCCC International Holding Ltd., also known as CCCI, would have been worth $1.5 billion. Source
  • Feds block Aecon proposed takeover by Chinese group for national security reasons

    Economic CTV News
    OTTAWA - The federal government has blocked Chinese state-owned CCCC International Holding Ltd.'s proposed $1.5 billion takeover of construction firm Aecon Group Inc. for reasons of national security. More coming. Source
  • Feds block $1.5B takeover of Aecon by China-owned company over national security

    Economic CTV News
    OTTAWA -- The federal government has blocked the proposed $1.5-billion takeover of Aecon Group Inc. by a Chinese state-owned company for reasons of national security. After markets closed Wednesday, a spokesman for Economic Development Minister Navdeep Bains confirmed the government's decision to prevent CCCC International Holding Ltd. Source
  • Canada blocks Aecon takeover by Chinese state-owned firm over national security

    Economic CTV News
    OTTAWA -- The federal government has blocked the proposed $1.5-billion takeover of Aecon Group Inc. by a Chinese state-owned company for reasons of national security. After markets closed Wednesday, Economic Development Minister Navdeep Bains confirmed the government's decision to prevent CCCC International Holding Ltd. Source
  • Northern B.C. gas pipeline designed to supply LNG industry wins NEB approval

    Economic CTV News
    CALGARY -- The National Energy Board has approved construction of a natural gas pipeline originally intended to supply the Pacific NorthWest LNG export terminal near Port Edward, B.C., even though that $36-billion project was cancelled last July. Source
  • Strike at Caesars Windsor postpones Blink-182, Russell Peters shows

    Economic CTV News
    WINDSOR, Ont. - An ongoing strike at Caesars Windsor has postponed more concerts, this time appearances by artists including Blink-182 and Russell Peters. The southern Ontario tourist draw says it is postponing concerts and cancelling hotel reservations through June 16. Source
  • Ecuadorian Villagers lose fight to have Chevron Canada pay US$9.5 billion

    Economic CTV News
    TORONTO -- The Canadian subsidiary of U.S.-based oil giant Chevron Corp. cannot be held liable for a US$9.5-billion award a court in Ecuador ordered against the parent company in favour of Ecuadorian villagers, Ontario's top court ruled on Wednesday. Source
  • Research needed on impact of microplastics on B.C. shellfish industry: study

    Economic CTV News
    VICTORIA -- A new scientific study says more needs to be known about the impact on oyster farms of microplastic pollution that has been found in waters off Vancouver Island. The report's authors say it would be prudent to assess the extent to which shellfish ingest microbeads, microfibres and microfragments after the pollution was found in the Baynes Sound, Lambert Channel and in areas off Denman and Hornby islands. Source
  • CN to purchase hundreds of grain cars as transportation bill becomes law

    Economic CTV News
    MONTREAL -- Canadian National Railway is preparing to purchase hundreds of new grain hopper cars to get shipments moving after a bill that encourages railways to make investments to avert service disruptions became law Wednesday. Source