Increasing Interest Rates and Economic Indicators

It looks like the low figure for growth in GDP for the first quarter of 2015, which was reported last week, may lead the Federal Reserve to delay its increase in interest rates.  There had been an expectation that the Fed would start increasing interest rates in June.  Now, however, with a reported 0.2% annualized growth in GDP for the first quarter, that may be put off until at least September.  A couple of comments.

First, when the Federal Reserve finally does start to raise interest rates, i.e., move toward letting the market set interest rates, it’s going to be a rough ride.  We have had below-market interest rates, set at virtually zero, for over six years.  It was necessary for a while.  Whether it has been necessary for the whole time is questionable. 

Whether necessary or not, interest rates set this low by the government are like a drug.  They give you an artificial high (in this case, probably higher stock and asset prices).  It feels nice, but eventually you have to stop taking it.  When addicts try to break the habit, it’s hard.  I think it is fair to say that it is going to be the same way when the Fed eventually eases off its near-zero percent interest rate policy.

One of the reasons it is going to be rough is that we really don’t really know what to expect.  The economy is always hard to predict (as you can see by how often the Fed’s own projections of growth, etc., are off).  This is going to be even harder.  We’ve never forced interest rates this low for this long.  The economic models people have developed have never dealt with this before.

All of which means that, as the Fed backs away from six years of near-zero interest rates, things aren’t necessarily going to go as we expect – because we don’t know what to expect.  The economic indicators could easily be all over the place, which brings me to my second point.

The government issues all kinds of economic numbers every month.  And every month thereafter, it corrects those numbers.  For example, that 0.2% annual growth rate in GDP for the first quarter of this year, will get changed.  I don’t know if it will go up or down, but it will change.  And sometimes these numbers get changed a lot.

Too often, it seems, the government decides to do one thing or another because some monthly number is high or low, and then a few months later, they find out that number wasn’t right – which means the policy decision they made based on that initial number may not have been right either.  It’s like the guy who lost his keys.  He looks for them where the street light shines, even though he lost them someplace else, because that is where the light is.  It seems that way with economic numbers.  We know they are going to change, but they are all we have, so we base our policies on them.

So what is the moral of this post?  Two things.  First, breaking the addiction to near-zero interest rates is going to be hard.  We don’t know what to expect.  And there could be lots of ups and downs as we adjust.

Second, as the Fed unwinds its near-zero interest rate policy, we shouldn’t overreact to preliminary numbers that will likely change anyway.  Knee-jerk reactions can make things worse, especially when we don’t know what is going to happen.

What we need to do is announce a policy and then follow it.  Certainty and confidence are more likely to succeed than reacting to monthly numbers like a bunch of second graders chasing a soccer ball.