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Raising rates signals things are "normalizing". It may be what's necessary to convince everyone that they really are. A lot of this is about the psychology of

by YZF 10y ago

Raising rates signals things are "normalizing". It may be what's necessary to convince everyone that they really are. A lot of this is about the psychology of the market and sometimes the psychology has to lead the change. When companies feel things are "normal" they will become less conservative with their investments. With a low interest rates, somewhat counter-intuitively, everyone has been in a fight or flight mode, sitting on troves of cash just because it seems too risky an environment to invest. My personal psychology here has been that if I can't get a good return on my investments I need to build them up rather than spend them. I am also concerned about exposing myself to bubbles. While in theory I should be encouraged to take risks in practice the risks in a low rate environment seem too high, especially if you consider one day the rates must go up. Historically we've had high inflation with significantly higher rates so I don't think the argument that low rates are a necessary condition for inflation holds. If anything the low rates appear to create deflationary pressure. Wages aren't rising because people and companies are not spending. Japan had low rates for 20 years and that hasn't done them much good. The last 10 year we had unusually low rates and by all accounts other than keeping the ship afloat not too much to show for those. It's time to try something else. Low rates inflate bubbles. Student loans. Car loans. Real estate. Stock market. Keeping rates too low for too long has many risks and those will grow. The current rates are still historically very low.

tempestn 10y ago
The essay actually addresses this right at the end, in the last paragraph before the conclusion: > One additional consideration that I think about is the possibility that low rates are scaring people and causing them to save more and invest less, while conventional wisdom is that low rates should lead to more investment and less saving. It is not a crazy argument because negative rates seem to be having unexpected results in some countries that have adopted them. If negative rates can scare people into saving more, perhaps very low rates can too? This would be an argument to raise rates just so people can feel more confident. However, it is hard for me to see how high rates by themselves can lead to more confidence, more spending and more investment. Take Japan: Should the Bank of Japan increase rates dramatically to send a confident signal? Does anyone think that would work in jump-starting Japan’s economy? I doubt it. A signal of confidence from higher rates must be coupled with strong underlying economic fundamentals. When the data indicate that we are approaching our dual mandate targets, I do believe markets will take some confidence from our rate increases because those higher rates will reflect strong economic fundamentals. I don’t find a strategy of raising rates purely as a psychological tool a compelling argument.
- YZF 10y ago
  Right. It's a chicken and egg though. The Fed isn't just raising rates. They're also saying we have full employment, inflation is up, so we can begin to normalize. Rates are still low and the increases are measured. Keeping them low would signal the Fed thinks something is wrong. EDIT: So far the small increases haven't had any adverse effects. If anything the opposite. So that's one counter-argument. The other thing to consider is that it's not the absolute rate or the derivative of the rate. It's the actions of the Fed vs. the market expectations. The expectation has been set for a long while that the Fed would try to normalize. If anything the Fed has not quite met the expectation. My last point is that the rates businesses borrow at are somewhat disconnected from the Fed rates, at times of higher perceived risk the premium vs. the Fed rate is higher. So the Fed raising rates doesn't necessarily increase costs to businesses.

by YZF 10y ago

tempestn 10y ago

The essay actually addresses this right at the end, in the last paragraph before the conclusion: > One additional consideration that I think about is the possibility that low rates are scaring people and causing them to save more and invest less, while conventional wisdom is that low rates should lead to more investment and less saving. It is not a crazy argument because negative rates seem to be having unexpected results in some countries that have adopted them. If negative rates can scare people into saving more, perhaps very low rates can too? This would be an argument to raise rates just so people can feel more confident. However, it is hard for me to see how high rates by themselves can lead to more confidence, more spending and more investment. Take Japan: Should the Bank of Japan increase rates dramatically to send a confident signal? Does anyone think that would work in jump-starting Japan’s economy? I doubt it. A signal of confidence from higher rates must be coupled with strong underlying economic fundamentals. When the data indicate that we are approaching our dual mandate targets, I do believe markets will take some confidence from our rate increases because those higher rates will reflect strong economic fundamentals. I don’t find a strategy of raising rates purely as a psychological tool a compelling argument.

YZF 10y ago
Right. It's a chicken and egg though. The Fed isn't just raising rates. They're also saying we have full employment, inflation is up, so we can begin to normalize. Rates are still low and the increases are measured. Keeping them low would signal the Fed thinks something is wrong. EDIT: So far the small increases haven't had any adverse effects. If anything the opposite. So that's one counter-argument. The other thing to consider is that it's not the absolute rate or the derivative of the rate. It's the actions of the Fed vs. the market expectations. The expectation has been set for a long while that the Fed would try to normalize. If anything the Fed has not quite met the expectation. My last point is that the rates businesses borrow at are somewhat disconnected from the Fed rates, at times of higher perceived risk the premium vs. the Fed rate is higher. So the Fed raising rates doesn't necessarily increase costs to businesses.