The short-term interest rates were kept unchanged on Thursday because historically, the US Federal Reserve has been a very conservative organization, said Gary Stern, former President of Minneapolis Federal Reserve.
While the markets are witnessing a volatile situation, economic conditions abroad have been deteriorating, and the Fed failed to achieve its inflation target. Amid such a scenario, it’s pretty easy for the policy makers to continue on the course they have been on. That said, whether that was the right decision or not could be a matter of debate, he noted.
While many market observers expected the Fed to raise rates Thursday, the Fed must be looking at a wide range of factors like the softening of export demands and heightened uncertainty overseas, said Randall Kroszner, a former Governor at the US Federal Reserve.
One of the issues that many may have missed is that market expectations for inflation have been moving down. Expectations for the next five years and ten years from today – the cyclical five-year-five-year forwards dipped a lot.
The forward inflation expectations were a key motivator for QE1 and QE2 and that has been bouncing around one to three quarters of a percent, significantly below where they had been earlier. So, it’s hard for policy makers to remain confident when the markets seem to have so little confidence, he added.
Asked if the stars would ever be in perfect alignment, and the Fed would continue to wait for the good times, Randy answered in negative. When Fed Chair Janet Yellen was asked if rates would ever be raised, she said there is a very high probability, but there’s no certainty.
There are always excuses for not acting as the Fed has traditionally been a conservative board which explains why the Fed has been behind the curve in the past despite seeing inflation, in order to ensure the foundation is there. Considering the current tenuous situation, their dithering is understandable. But it’s likely that they would have the conviction to make the first move soon, he noted.
Asked if the Fed would act this year because there’s no press-conference in October and December may look like a window dressing, Gary said while there’s no doubt October is off the table, there’s no need to assume window dressing precludes December.
However, there’s very little probability of a rate hike in December, although Janet Yellen was trying to balance the scales in her commentary. So the next move is more likely to come next year some time.
If the Fed, however, waits for all the stars to align, it will end up waiting forever, particularly if they put global economic conditions so blatantly in their official statement, a rate hike may never happen in future.
In reality, however, developments in the labor market may trigger a rate hike in future. Until that occurs, policymakers seem to have given themselves lots of leeway to continue with the very accommodative policy that has been in place for a long time, he concluded.
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