The Federal Reserve Must Raise Rates

The Federal Reserve’s credibility requires it to raise interest rates at its meeting this week. The reason is that otherwise it would appear to be giving in to the US President, who has been criticizing the Fed and blaming it for causing financial market turmoil. If the Fed does not raise interest rates in response, the President will have shown that he has power and influence over the Fed. The Fed must prove its independence.

The only justification the Fed could have to not raise interest rates at this meeting would to be a major deterioration in the world economy. There are some indications of weakening in China and Europe but not enough for the Fed to be overly concerned. The Fed has been on a trajectory of gradual tightening to bring monetary policy to a neutral position after a decade of easy money. The Fed needs to continue on this trajectory.

From an economist’s point of view, in fact, it is the President and Congress, not the Fed, that are raising interest rates. The President and Congress are using expansionary fiscal policy, with a large tax cut and increased government spending. As a result, the rapidly growing deficit is leading to higher interest rates, not the Federal Reserve. The government’s borrowing needs are putting pressure on financial markets to absorb more and more debt, which can only happen with higher long-term interest rates. The upward movement of those interest rates then requires the Fed to raise the short-term federal funds rates to keep pace. Failing to do so would lead to the Fed falling behind the curve and to higher future inflation.

Should the Fed not raise interest rates at its meeting this week, its low level of credibility will shrink even more. After the disaster of the Great Recession of 2007 to 2009, the Fed needs to do everything it can to regain the public’s trust. An increase in interest rates would help. If the first quarter inflation numbers rise, as seems likely, the Fed will need to raise interest rates even faster in 2019 than it did in 2018.

Fed Chair Powell may have the respect of economists within the Fed but has no credibility outside the Federal Reserve System. It is time for him to change that.

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