As the Federal Open Market Committee meets, is the US economy ready for higher interest rates?

Janet Yellen
Interest rates are set to rise in the US (Source: Getty)

Shaun Richards, an independent economist, says Yes.

The situation facing the United States has two major features. The most immediate one is the rise in inflation, with the consumer price index rising by 2.5 per cent on a year before in January, and the personal consumption expenditure method rising by 1.9 per cent.

These are much higher than the current level of official interest rates, implying negative real returns and yields.

Next comes the issue of how long interest rates can remain low without damaging the economy. After all, each increase is only 0.25 per cent these days – if we cannot take that then there are worrying implications for the state of economic play.

But savers and pension funds need some balance in the situation versus debtors – it is approaching a “lost decade” for them. Thus, with inflation rising and the side effects of keeping interest rates low for so long building, the real issue is if not now, then when? The world economy needs a better balance than what it has at the moment.

Danny Blanchflower, an economics professor at Dartmouth College and a former Bank of England MPC member, says No.

The Fed should not be raising rates. There is zero in the data for the real economy supporting such an increase.

There is huge uncertainty in what will happen on the fiscal front. Repealing and replacing Obamacare is dead on arrival, given the Congressional Budget Office report saying 24m people will lose coverage. There are no plans for tax cuts or infrastructure.

GDP growth for the fourth quarter of 2016 disappointed at 1.9 per cent. If the economy was anywhere close to full employment, wage growth would be flying and it isn’t. The latest release of the Employment Cost Index showed a rise of only 2.2 per cent.

The employment rate is over three percentage points below what it was in 2008. It would take an additional 9m jobs to get back to pre-recession levels. There are also high levels of underemployment, with the number of part-timers who want full-time jobs 1.5m above 2007 levels. Bad idea. Fingers crossed.

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