WAIT, NOT SO FAST ON THIS TALK OF FED EASING / THE WALL STREET JOURNAL

Wait, Not So Fast on This Talk of Fed Easing

By Jon Hilsenrath


The market turbulence of the last few days is rapidly changing the public’s conversation about the outlook for Federal Reserve policy. Some prominent public figures -- Harvard professor Lawrence Summers and Bridgewater Associates head Ray Dalio – are arguing the Fed’s next move might be to ease monetary policy, perhaps by launching a new bond buying program. That would be a big switch because the Fed has been signaling for months it intends to tighten policy by raising short-term interest rates before year-end.

It is worth remembering some 1990s history in the context of this discussion. Federal Reserve officials were embroiled in intense debates in 1996 about whether to raise interest rates. Seeing the U.S. jobless rate decline, Fed governors including Janet Yellen believed slack was diminishing in the domestic economy and inflation pressure bound to build. They raised rates a notch in March 1997 from 5.25% to 5.5%. The U.S. jobless rate then was 5.2% at the time, a 10th of a percentage point below where it was this past July. The Asian financial crisis then threw Fed officials for a loop. They sat tight and watched for a year as it worsened. Then between September and November of 1998, with Asia and Russia’s economy melting down, the Fed cut rates three times in quick succession to 4.75%. When the crisis settled, within a few months, they were back on course, raising rates to 6.5% by May 2000. The U.S. emerged from this period with a technology bubble.

A few points come out of this history:

First, the Asian financial crisis was more than a year old and it had morphed into a global crisis when the Fed responded by cutting rates in 1998. You can’t dismiss the possibility that the Fed might end up deciding to ease policy in this episode. China is too big and the world economy has proved too unstable and unpredictable to be sure it won’t happen. But it isn’t likely to happen any time soon. The Fed is a very inertial institution and it is oriented toward raising rates, not easing.

Second, the Fed’s rate cuts in the fall of 1998 were a brief interlude in what ended up being a cycle of interest rate increases. It moved because the domestic economy strengthened and the jobless rate fell. The Fed is now oriented toward raising rates because it sees the domestic economy strengthening and the jobless rate falling. As long as the Fed is confident that will continue, it will remain oriented toward raising rates, not easing.

Third, the Fed raised short-term interest rates to 5.5% when the jobless rate was 5.2%. It had a relatively small and stable portfolio of bond holdings at the time. The jobless rate was 5.3% in July and U.S. short-term rates are near zero. The Fed’s balance sheet is near $4.5 trillion. Officials see U.S. monetary policy as already extraordinarily easy. They are not inclined to make it easier.

Fourth, don’t dismiss the possibility that the U.S. could emerge from this period with yet another bubble, as it did in the late 1990s. That sounds like an odd thing to say when the stock market is in correction territory. But interest rates are very low. Money has to go somewhere and it isn’t going into China. U.S. real-estate prices are on the rise again. It could be the Fed’s next problem a few years down the road.