Raise Rates, Don’t Raise Rates, Who’s Right?

Raise Rates, Don’t Raise Rates, Who’s Right?

Raise Rates, Don’t Raise Rates, Who’s Right?


There are those economists that argue that the US Fed should take an unconventional approach to ending a long period of below-target inflation: that being that instead of keeping interest rates low to drive economic activity and push up prices, it should raise interest rates.

Dubbed “Neo-Fisherism” Noah Smith after the famous monetary economist Irving Fisher.

Narayana Kocherlakota, the Lionel W. McKenzie professor of economics at the University of Rochester, and the former President of the Federal Reserve Bank of Minneapolis from Y’s 2009 – 2015 says this is dangerous;

Here he explains why he think it is dangerous: “Neo-Fisherites believe that modern economies are self-stabilizing. Specifically, they think that, regardless of what monetary policy makers do or don’t do, the real interest rate — the rate that matters for people’s and businesses’ decisions to borrow and spend — has to adjust over the longer run to ensure that the economy is in equilibrium. Because the real rate consists simply of the nominal rate minus inflation expectations, this leads to some unusual policy recommendations.

Suppose, for example, the long-run equilibrium real rate is 2 percent. Neo-Fisherites would predict that if the Fed holds nominal rates at 0.5 percent for too long, people’s inflation forecasts will eventually have to turn negative — to minus 1.5 — to get the real rate back to 2. Conversely, if the Fed raises its rate target to 4 percent and keeps it there, inflation expectations will rise to 2 percent. Because such expectations tend to be self-fulfilling, the result will be precisely the amount of inflation that the Fed is seeking to generate.

Traditional economic models, by contrast, predict the opposite. If the central bank raises rates and credibly commits to keeping them high, people and businesses become less willing to borrow money to invest and spend. This undermines demand for goods and services, putting downward pressure on employment and prices. As a result, the economy can plunge into a deflationary spiral of the kind that afflicted the U.S. in the early 1930’s.

So who’s right? Let’s look at the recent evidence in the U.S. Here’s a chart showing the short-term interest rate that the Fed controls, along with a measure of longer-term inflation expectations derived from the prices of Treasury securities: The Fed held the nominal interest rate near zero from late 2008 until late 2015 — a policy that, according to Neo-Fisherites, should have driven inflation expectations into negative territory. Yet they stayed roughly the same for most of that period. They started to slide downward only after the Fed began to tighten policy in May 2013 by signaling that it would pull back on the bond purchases known as QE (quantitative easing). Also, the recent modest increase in the nominal rate has not led to a commensurate increase in inflation expectations.

Granted, that’s just one piece of evidence from one country. Nonetheless, it would be remarkably irresponsible to take the risk of raising rates based purely on a theoretical belief in macroeconomic self-stabilization.

I, too, once believed that the horrific events of the early 1930’s, when economic output fell by a quarter and prices by even more, could not recur in a modern capitalist economy like the US. Then 2008 happened, and we all learned where a religious belief in the self-correcting nature of markets can lead us. If we want stability, we have to choose the right policies. Raising rates in the face of low inflation is not one of them.”

Wednesday, the US major stock market indexes finished at: DJIA +36.02 at 18595.03, NAS Comp +53.56 at 5089.93, S&P 500 +9.24 at 2173.02

Volume: Trade was light with about 723-M/shares exchanged on the NYSE

  • DJIA +6.7% YTD
  • Russell 2000 +6.5% YTD
  • S&P 500 +6.3% YTD
  • NAS Comp +1.7% YTD
HeffX-LTN Analysis for DIA: Overall Short Intermediate Long
Bullish (0.31) Neutral (0.19) Very Bullish (0.50) Bullish (0.25)
HeffX-LTN Analysis for SPY: Overall Short Intermediate Long
Bullish (0.25) Bullish (0.25) Bullish (0.35) Neutral (0.14)
HeffX-LTN Analysis for QQQ: Overall Short Intermediate Long
Bullish (0.31) Neutral (0.06) Very Bullish (0.56) Bullish (0.31)
HeffX-LTN Analysis for VXX: Overall Short Intermediate Long
Bearish (-0.32) Bearish (-0.36) Bearish (-0.33) Bearish (-0.25)

Stay tuned…


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