The International Monetary Fund today issued unusually direct and specific advice to the Federal Reserve about when interest rates ought to be allowed to start rising again.
Through its intentionally vague policy statements, the Fed has suggested that a “liftoff” from the current zero-rate is likely to occur near the end of this year. In its annual review of the state of the U.S. economy released today, the IMF cut growth estimates for 2016 from 3.1 percent to 2.5 percent, and it called on Fed policymakers to hold off on any interest rate hike until 2016. The Fund warned that the central bank’s Federal Open Market Committee risks its credibility with the markets if it hikes rates and then has to backtrack.
“Raising rates too soon could trigger a greater-than-expected tightening of financial conditions or a bout of financial instability, causing the economy to stall,” the IMF statement said. “This would likely force the Fed to reverse direction, moving rates back down toward zero with potential costs to credibility.”
Financial markets professionals said that the practical impact of the IMF statement on Fed policy would likely be negligible. “The Fed will pay no attention,” said John Canally, chief economic strategist for LPL Financial. “This is not some kind of coordinated thing. They are data dependent. If the data suggests they should wait, they’ll wait; if it says they should raise rates, they’ll raise them.”
However, the IMF statement, released in conjunction with a press conference featuring the Fund’s high-profile managing director, Christine Lagarde, raised some eyebrows among those who follow monetary policy debates, if only because of its directness. It also caused a stir in the financial markets, as investors considered the possibility of an even longer era of ultra-low rates.
Mohamed A. El-Erian, the former CEO of investment firm PIMCO and current chief economic advisor to German financial services powerhouse Allianz, expressed his surprise on Twitter.
The Fund’s analysis of the questions facing the FOMC included the caveat that waiting too long to increase rates could also have negative effects, including “an acceleration of inflation above the Fed’s 2 percent medium-term objective with monetary policy left having to play catch-up. This could require a more rapid path upward for policy rates with unforeseen consequences, including for financial stability.”
On balance though, the report concluded, “there is a strong case for waiting to raise rates until there are more tangible signs of wage or price inflation than are currently evident.” The report added that a number of factors suggest that wages or consumer prices are unlikely to spike suddenly.
The Fund also made a somewhat unusual appeal centered on the effects that decisions made in Washington have on the international economy. “The Fed’s first rate increase in almost nine years has been carefully prepared and telegraphed,” the statement said. “Nevertheless, regardless of timing, higher U.S. policy rates could still result in a significant and abrupt rebalancing of international portfolios with market volatility and financial stability consequences that go well beyond U.S. borders.”
If the Fed misplays its hand, the Fund warned, “asset price volatility could last more than just a few days and have larger-than-anticipated negative effects on financial conditions, growth, labor markets, and inflation outcomes. Spillovers to economies with close trade and financial linkages could be substantial.”
In the end, though, the IMF may not be suggesting something wildly different from what the FOMC seems to be planning. According to the “dot plot” projections from the last FOMC press conference in March, a majority of voting members see rates beginning to rise by yearend, but remaining below 2 percent by the end of 2016. The IMF suggests “a later lift-off could imply a faster pace of rate increases,” which could wind up getting to the same place by a slightly different route.
There are even some on the FOMC who, judging by the limited amount of information available about the members’ thinking, share the IMF’s view. The IMF recommendation “seems to add credibility to that view which is shared by some but not all on the FOMC,”said David Wessel, director of the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy.
Wessel noted that while the IMF’s interest rate comments garnered the most attention, it also took U.S. lawmakers to task for a fiscal policy that, in the Fund’s view, is too focused on the deficit to the exclusion of investment in future growth. That position tracks that of a paper by a trio of IMF researchers, released this week, calling on the U.S. and other countries in relatively good fiscal condition to avoid policies that use tax revenue to pay down low-interest debt.
“On the fiscal front the IMF adds its voice to the one-two punch fiscal policy that — unfortunately — Congress won't try,” said Wessel. “It essentially calls for less worry about today's deficit to spend more now on productivity-enhancing investments in physical and human capital and more worry (and action) about the out years. It is frustrating that Congress can't get that message.”
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