Economy, Issues

Fed hikes interest rate to as high as 1.25 percent—cites ‘ongoing strength of the economy’

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The Federal Reserve just raised interest rates, which is fairly common action to stop the economy from overheating, but this is leaving Americans, particularly young Americans, wondering where the fire is? Considering sluggish economic growth has been pervasive

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Kurtis Garbutt CC by 2.0

through all elements of the economy since the last recession in 2008 and 2009, the central bank’s slow agenda on interest rates could be a signal of worse economic conditions to come.

In 1979, crisis hit when inflation rose from over 6 percent to nearly 15 percent. To combat what was seen as spiraling inflation, then Fed Chairman Paul Volcker nearly doubled interest rates sending the nation into an unavoidable recession. The Fed’s slow dropping of these interest rates as the economy improved is credited with helping to bring the country out of this recession and stabilized inflation.

Interest rates and inflation have dropping long-term the past three decades ever since.

Now, Fed Chairwoman Janet Yellen is being faced with another dilemma.

Following the 2008 recession the Federal Reserve dropped interest rates to a near zero percent to moderate inflation and stabilize the economy. But despite the recession beginning nearly a decade ago, the Fed waited eight years to significantly raise interest rates, until today they were barely hitting 1 percent.

Now, Yellen is touting the “ongoing strength of the economy” to justify a meager 0.25 percent increase in rates to as high as 1.25 percent.

Yet, in the first quarter of 2017, Gross Domestic Product (GDP) only rose at an annual rate of 1.2 percent; yet Yellen still believes by the end of the year GDP will reach 2.2 percent. Yet in order for this to be possible, in each quarter for the rest of the year the U.S. GDP will have to reach 2.5 percent, a seemingly impossible feat considering only three quarters in the last two years have even been over two percent.

Another justification for the slim rate hike was the recent unemployment report that indicated that the U.S. was near full employment, but this widely distorts actual employment trends.

Labor force participation has been at its lowest in years, particularly in the working age population of 16 to 64. In the last 20 years labor participation has dropped dramatically, accounting for 7.5 million Americans who would have jobs had participation remained the same.

If as many working age adults were participating in labor markets as in 1997, the unemployment figure goes from 4.3 percent, as Yellen boasted, to 9.4 percent, a much more startling figure.

Yellen justified raising interest rates now because “In the labor market, job gains have averaged about 160,000 per month since the start of the year — a solid rate of growth that, although a little slower than last year, remains well above estimates of the pace necessary to absorb new entrants to the labor force.”

Although recent job gains have come with a slight increase in labor participation among 16-64 years olds, there are millions more to go just to get back to where we were.

Historically, slow climbs in interest rates appear to make sense to offset slower inflation spikes, but due to increased efficiency in our overall economy, inflation has been generally much lower making it less correlative with interest rates and the overall economy. As Yellen attempts to “normalize” interest rates, she must question what normal actually is in our ever changing economy.

Our economy is not doing well and projected GDP growth and the unemployment rate are misleading indicators on performance. Yellen should look to international trends.

Countries across Europe and even Japan have seen little to no economic growth in nearly 20 years, the U.S. might simply be a decade or so behind this same trend as the population ages. Meaning another economic recession could be right around the corner.

As the Boston Globe’s Evan Horowitz of Dec. 2016 warns, “Not once in the full sweep of history has the United States gone more than 10 years without a recession. We’re seven years into our slow but steady recovery…Ideally, when a recession hits, the Federal Reserve would be able to cut the federal funds rate by 4 to 5 percentage points. That’s what it did during the slowdown in 2001 and again in 2007-2008.”

Janet Yellen’s modest 0.25 percent increase on interest rates might seem to match the slow and steady pace of our economy but it does not provide flexibility in the event of an economic downturn. A projection of 2.2 percent GDP growth is simply not enough, the U.S. needs to hit at least 3 to 4 percent growth if it hopes to make up for the damage done over the last 10 years. Then our economy will be able to handle a 0.25 percent increase in interest rates, but right now Yellen must move as far away from zero as possible to allow for a drop.

Forbes’ Susan Lee of April 2009 argued, “It really is all Greenspan’s fault” in regards to the Fed Chairman Alan Greenspan’s action during the 2008 recession because he waited until 2006 to raise interest rates above five percent, citing the criticism of Stanford economist John Taylor. Greenspan chose the gradual approach for too long and provided much greater shock to the system when he did finally hike rates. Is Yellen making the same mistake?

What it really looks like is Yellen is preparing the economy for a recession by moving the number away from zero. But 1.25 percent may not be high enough if a recession comes sooner than she anticipates. Usually, one expects interest rate hikes in an overheating economy, but ours is barely running at capacity. The Fed may have already waited too long.

This is a guest post by Natalia Castro a contributing editor at Americans for Limited Government.

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