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When will Fed raise interest rates?
In April the Fed announced a fourth $10 billion reduction to its Quantitative Easing (QE) program, reducing its monthly bond purchases to $45 billion and keeping pace to end the program by December.
The FOMC will have to exit its near zero interest rates and its bloated balance sheet, which should be around $4.5 trillion by December 2014. The question will be how fast and how high should interest rates rise? Both sides probably agree that “normalizing”
San Francisco Fed President John Williams, a dove, believes a tightening policy of raising the fed funds rates is still a good way off. He does not see a return to a normal U.S. job market and increased inflation until 2016. Minneapolis Fed President Narayana Kocherlakota, also a dove, does not believe inflation will climb back to 2 percent until 2018. He believes the Fed should overshoot it inflation target for a few years to make up for the current period of low prices.
Philadelphia Fed president, Charles Plosser, a hawk, believes the Fed is sitting on a ticking bomb. He is worried about over $2.5 trillion in banking excess reserves. He is concerned that if borrowing begins to surge, excess banking reserves could pour out of the banking system and put pressure on inflation.
The doves are concerned that if the Fed raises interest rates to soon and too fast, the economy will fall back into a recession. The hawks believe the Fed normally reacts too late, and allows inflation and financial bubbles to get out of control. Doves such as Janet Yellen and New York Fed President William Dudley, argue that withdrawing reserves too quickly is a bigger danger than reducing them too slowly, as hawks Plosser and Fisher fear.
Normally the hawks, who are often practical regional bankers, are ignored by the largely theoretical Ph.D. economists appointed as the Fed Chair and Governors by politicians. Only four regional bankers vote annually on a rotating basis. The New York Fed president, who represents the large banks, votes on a continual basis. Normally the hawks are only figure heads with no real voice. However, Vice-Chairman, Stanley Fischer may give the hawks some voting power. If inflation exceeds 2.5% he will probably join the hawks in wanting to reign in the economy.
Research by Joseph Haubrich, an economist with the Cleveland Fed Bank, shows that recessions normally follow an inverted yield curve (when short rates exceed long rates) within one year. The yield curve inverted in August 2006, a bit more than a year before the recession of 2007. With Fed Funds at almost zero, it is difficult to see a recession in the near future. However, if the Fed raises interest rates quickly in 2015, and the yield curve becomes inverted, Haubrich would expect a recession in 2016.
Some financial pundits believe the ending of QE3 will cause a recession. However, the banks are starting to lend and M3 is growing at 5%. Even if the Fed stops printing money through its bond purchases, there are enough excess reserves for credit to expand substantially.
The next FMOC meeting will be on June 17th. With much hotter CPI and PPI reports the last two months, and another hot set coming in June, some analysts expect fireworks between the hawks and doves on forward guidance, and future Fed policy in regards to interest rates.
Some historians believe lack of financial discipline is a sign of moral decay. Currently gold is moving from West to East as gold trading moves from New York and London to Shanghai. Tea Par Culture War.com is a conservative blog designed for the U.S. market. However, on a 3 to 1 basis, the largest readership is in China, followed by France.
It is important to remember that the Romans and Greeks devalued their metal currencies by replacing precious metals with base metals. However, hyperinflation has only occurred with fiat paper money, in nations such as China, Germany, France and Zimbabwe.
Dr. Stephen Johnston
Page Updated Last on: May 29, 2014