Doomsayers are wrong (so far) as U.S. Fed raises rates: Don Pittis
Breaking the ice on frozen rates has calmed markets, not roiled them
"Remember, we have very low rates and we've made a very small move."
With those words, U.S. Federal Reserve chair Janet Yellen meant to reassure ordinary Americans that yesterday's quarter-point hike in interest rates, labelled "historic" after seven years near zero, was really nothing much to worry about.
With everyone from Harvard's Larry Summers, to IMF boss Christine Lagarde to the Financial Times warning of the economic risk of raising rates, it appears that, so far at least, Yellen's reassuring words were effective far beyond Main Street, extending to financial markets around the world.
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If there are economists who think interest rates should stay at zero forever, I've never met them. So the issue was not whether rates should rise, but when.
With almost two years in the job as head of the world's most powerful central bank, Yellen was able to present a calm and rational case for why the Fed did have to move now.
As some predicted earlier this year, the announcement of a rise in rates was far more soothing than the speculation and doomsaying that came before.
Challenged at yesterday's news conference by a reporter who quipped central banks often kill off periods of economic growth by raising rates, Yellen had a confident response. She said the reason that sometimes happened was that central banks moved too late, allowing inflation to get out of control.
"At that point they've had to [raise interest rates] very abruptly and very substantially," said Yellen. "And it has caused a downturn, and the downturn has served to lower inflation."
The Fed chair and her team of advisers are confident that the current interest rates will allow the economy to grow. But she expects this is just the first in a series of increases in Fed rates, rising from the 0.25 per cent range today to more than three per cent by 2018. And though gradual, those increases will have an effect, including on Canadians.
Now that Yellen has made this first move, Canadian homeowners and other borrowers must consider the prospect that some interest rates may rise by as much as three percentage points over the next three years.
Janet Yellen, zombie killer
Those gradual rate rises are also likely to have an effect on companies worldwide that have become over-dependent on debt. They are sometimes called zombies, because low interest rates allow them to continue to operate longer after a normal market would have killed them off.
Inevitably such firms, including over-extended small oil-drillers in the United States, will go out of business. While that will be painful for the individuals involved, a growing economy will be able make better use of those resources currently being used to flood the world with more unwanted oil, aiding an oil price recovery.
As a growing U.S. economy begins to use up its supplies of labour and capital, it will begin looking to its neighbours.
Yellen has said before and made clear yesterday, an American economy where interest rates have to rise is good for both U.S. citizens and the world. That is because rates will only rise when the U.S. central bank sees signs that inflation and the demand for labour are continuing to rise.
Exports may be weak, she said, but the U.S. domestic economy is showing signs of life with consumer spending and house-building on the rise.
10% chance of a shock
While Yellen expressed confidence in the U.S. economy, saying there was no sign the current growth phase would "die of old age," she doesn't have a crystal ball. She acknowledged that some unpredictable economic shock could come and knock the U.S. economy off track. In fact, she said, there was something in the order of a 10 per cent chance of that happening.
She even followed the lead of Bank of Canada governor Stephen Poloz and mentioned the possibility of negative interest rates if things got really bad, although she did not foresee using them.
For central bankers, the only tried and true way of dealing with a major economic shock is to lower interest rates, something difficult to do when rates are already at zero. And that, she said, is another good reason to start increasing rates sooner rather than later.
"One factor that we've talked about is the desirability of having some scope to respond to an adverse shock to the economy by lowering the federal funds rate," said Yellen. "It would be nice to have a buffer in terms of having raised [rates] to a certain extent to give us some meaningful scope to respond."
Follow Don on Twitter @don_pittis
More analysis by Don Pittis
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