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

  • North Dakota officials beg last pipeline protesters to leave

    Economic CTV News
    CANNON BALL, N.D. - Public officials in North Dakota pleaded with the remaining protesters at the Dakota Access oil pipeline camp to pack up and leave so authorities can resume cleaning up the premises without any further arrests. Source
  • Asian stocks dip as U.S. rate hike mooted

    Economic CTV News
    HONG KONG - Asian shares slipped Thursday after the latest Fed minutes raised the possibility that a U.S. rate hike could come sooner than expected. KEEPING SCORE: Japan's benchmark Nikkei 225 lost 0.4 per cent to 19,312.07 and South Korea's Kospi dipped 0.1 per cent to 2,104.70. Source
  • Tesla swings to lost in 4Q, says Model 3 on target

    Economic CTV News
    DETROIT -- Unable to string together profitable quarters, electric car and solar cell maker Tesla Inc. reported a loss for the last three months of 2016. Tesla posted its first profit in three years in last year's third quarter and had predicted net income in the fourth quarter. Source
  • Tesla swings to loss in 4Q, says Model 3 on target

    Economic CTV News
    DETROIT -- Unable to string together profitable quarters, electric car and solar cell maker Tesla Inc. reported a loss for the last three months of 2016. Tesla posted its first profit in three years in last year's third quarter and had predicted net income in the fourth quarter. Source
  • United Airlines enters basic economy fare wars in the U.S.

    Economic CTV News
    On Tuesday, United began selling basic economy fare tickets on select domestic routes in the U.S., joining American Airlines and Delta in offering a budget option for fliers. It's a move aimed at staying competitive in a market that's becoming increasingly crowded with low-cost and ultra-low cost carriers. Source
  • SodaStream recalls bottles at risk of bursting

    Economic CBC News
    SodaStream Canada has recalled some one-litre bottles because consumers could be injured if the bottles rupture while the contents are being carbonated. The recall was issued jointly by Health Canada, the United States Consumer Product Safety Commission and SodaStream Canada Ltd. Source
  • Good news for Bombardier? Business jet sales may be bolstered by Trump tax cuts

    Economic CTV News
    MONTREAL -- The U.S. government's plan to cut corporate taxes will bolster the business jet industry which last year had its weakest performance since 2004, an association representing the sector said Wednesday. "It will be a good shot in the arm for the industry," said Pete Bunce, CEO of the General Aviation Manufacturers Association. Source
  • Tim Horton's parent buys Popeyes chicken

    Economic CTV News
    Restaurant Brands International, the parent company of Burger King and Canada's Tim Hortons donut shops, said Tuesday it has reached a deal to buy American fried chicken chain Popeyes Louisiana Kitchen. The sale price is US$1.8 billion, or US$79 per share, according to a statement, representing a 27 percent premium over Popeyes' recent average stock price. Source
  • Apple acquires facial recognition start-up

    Economic CTV News
    RealFace specializes in developing artificial intelligence (AI) based facial recognition software. Its first consumer application, Pickeez, can find all the photos of a given person on a smartphone or in a Facebook folder and can even pick the best shots. Source
  • TransCanada asks shippers to support new natural gas pipeline tolls

    Economic CTV News
    CALGARY -- TransCanada (TSX:TRP) is proposing a new pipeline tolling system it says will allow western Canadian natural gas to be shipped to Ontario at lower rates to better compete with growing American supplies. The Calgary-based energy transport company is inviting shippers to sign long-term binding commitments by March 9 to move gas on its underutilized Canadian Mainline system from a shipping centre in Alberta to a hub in southern Ontario. Source