Federal Reserve Gradualism: A Dangerous Game?

By | December 26, 2015

In a move many market participants felt was long overdue, at its most recent meeting the Fed raised the fed funds rate .25%!

And, after parsing the language in Janet Yellen’s statement, the belief is that 2016 may see two or three more hikes of .25% each leaving the fed funds rate in the .75%-1% range at the end of the year.

If this rate of increase is assumed to be the norm, it will take the Fed as long as four years to reach the normalized fed funds rate of 3%.

Former Morgan Stanley chief economist and now member of the Yale University faculty, Stephen S. Roach, has a problem with this chosen methodology and monetary policy strategy!

Below is an excerpt from an article he wrote at Project Syndicate titled…

The Perils of Fed Gradualism

…Today’s Fed inherits the deeply entrenched moral hazard of the Asset Economy. In carefully crafted, highly conditional language, it is signaling much greater gradualism relative to its normalization strategy of a decade ago. The debate in the markets is whether there will be two or three rate hikes of 25 basis points per year – suggesting that it could take as long as four years to return the federal funds rate to a 3% norm.

But, as the experience of 2004-2007 revealed, the excess liquidity spawned by gradual normalization leaves financial markets predisposed to excesses and accidents. With prospects for a much longer normalization, those risks are all the more worrisome. Early warning signs of troubles in high-yield markets, emerging-market debt, and eurozone interest-rate derivatives markets are particularly worrisome in this regard.

The longer the Fed remains trapped in this mindset, the tougher its dilemma becomes – and the greater the systemic risks in financial markets and the asset-dependent US economy. It will take a fiercely independent central bank to wean the real economy from the markets. A Fed caught up in the political economy of the growth debate is incapable of performing that function.

Only by shortening the normalization timeline can the Fed hope to reduce the build-up of systemic risks. The sooner the Fed takes on the markets, the less likely the markets will be to take on the economy. Yes, a steeper normalization path would produce an outcry. But that would be far preferable to another devastating crisis…‘ Read the entire article here.

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Michael Haltman is President of Hallmark Abstract Service in New York. He can be reached at mhaltman@hallmarkabstractllc.com.

One thought on “Federal Reserve Gradualism: A Dangerous Game?

  1. Pingback: If Money-Printing Equals Inflation, Why Don’t We Have Any? | Hallmark Abstract LLC

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