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The last time the Federal Reserve raised interest rates it was two 2006 — before the housing bubble burst, before the collapse of Lehman Brothers, and before 10% unemployment. Since the start of the Great Recession, in 2008, the Fed has kept rates near zero. But now observers say that is about to change. At their meeting tomorrow, they are expected to announce a quarter percent increase. For some economists, this is long overdue. For others, the data is not there to support a hike. Diane and her guests discuss what higher rates could mean for the economy, small businesses and consumers.
- Douglas Holtz-Eakin President of the American Action Forum; chief economist and director (2003-2006), Congressional Budget Office
- Dean Baker Co-director, Center for Economic and Policy Research and blogger, Beat the Press; author of "The End of Loser Liberalism: Making Markets Progressive"
- Neil Irwin Senior economics correspondent, The New York Times; author of “The Alchemists: Three Central Bankers and a World on Fire" (2013).
NOTE: Due to technical problems, this broadcast of The Diane Rehm Show was shorter than usual.
MS. DIANE REHMAnd apologies to all of you. Welcome, I'm Diane Rehm. We've had some technical difficulties this morning. But now we're going to turn to the subject matter we promised you, that is, the anticipated raise in interest rates by the Federal Reserve that could and likely will happen tomorrow. Here in the studio, Douglas Holtz-Eakin of the American Action Forum, Dean Baker of the Center for Economic and Policy Research, and Neil Irwin of The New York Times. Neil Irwin, this seems like a pivotal moment for the country, for the economics underlying the country and for the Fed. Tell us.
MR. NEIL IRWINI think it is. You know, it was exactly seven years ago, in December of 2008, when the Federal Reserve moved to zero interest rates. That was, of course, during the -- some of the darkest period of the economic crisis that affected the world economy so much back in the fall of '08. And we've been at zero interest rate since. So there's been three rounds of quantitative easing, all kinds of unconventional mechanisms the Fed has tried to use to pump up economic growth. And this is a sign that there's some sense of repair, not that the economy is fixed or is completely healed. But we have 5 percent unemployment, we have steady growth for about six years now.
MR. NEIL IRWINAnd this is a sign that the Fed believes, at least, that things are good enough that we can pull away this life support, this thing that's been keeping the economy afloat.
REHMSo how unusual, Douglas, is it that we would do this in the midst of a presidential campaign?
MR. DOUGLAS HOLTZ-EAKINWell, I don't think it's unusual for the Fed to move during a primary season, you know, a year away from the election itself. But when we get to the fall of 2016, it'll be interesting to see if the Fed feels like it should go on hold during the campaign for the general election.
REHMDean Baker, why has it taken so long for the Fed?
MR. DEAN BAKERWell, I think the reason has been that the economy has been very, very weak. And even today, I mean, we could look at the 5 percent unemployment rate and say that doesn't seem too bad. But there's a whole range of other labor-market statistics that still make the economy look very, very weak. And just to give you a few quick ones, if we look at the employment rate, the percentage -- and we could restrict it to prime-age workers, 25 to 54, these aren't people retiring -- we're down by three full percentage points from where we were pre-recession levels. That looks like a recession.
MR. DEAN BAKERIf we look at the number of people who are working part time involuntarily, that also looks like a recession. Duration -- the average median duration of unemployment spells. That also looks like a recession.
REHMSo if it were up to you, you'd keep interest rates right where they are.
BAKERYeah, well just to be clear, I don't think the quarter-point hike -- and I agree with everyone here that we're likely to see that tomorrow -- I don't think that's that big a deal. But I think it's headed in the wrong direction. What I really worry about is if it puts us on a path towards rapidly increasing rates, which will slow the economy, slow the rate of job creation.
REHMAnd what about inflation? What about the hike in interest rates? What affect could it have.
HOLTZ-EAKINWell, the hike in interest rates is anticipated to cut off future inflation. You know, we really have a pretty interesting inflation situation. If you look at goods, we have had deflation outright during the recovery. The average rate of inflation is under 1 percent for goods that consumers buy. I f you look at services, it's right on the Fed's mark. So they have a reason to be looking at the raise.
REHMDouglas Holtz-Eakin, Dean Baker, Neil Irwin, as we talk about interest rates. If you'd like to join us, give us a call, send us an email. Short break here. Stay with us.
REHMAnd welcome back as we talk about anticipated rate hike from the Fed. Tomorrow, Neil Irwin, it's what's expected. People are talking about a quarter-percent rate. Is that what you see happening?
IRWINIt is. You know, every signal we've been getting out of the Federal Reserve the last few weeks is that this is the time, they're ready to pull the trigger. It will be small, it'll be a quarter percentage point, most likely. The question really is not just what they're going to do tomorrow, though, what are they going to do in 2016, how -- what will the path look like. Will they, you know, raise again in March, let's say? Will they keep doing...
REHMWhy would they? Why would they, having waited so long for this first rate hike, why would they then do one so quickly?
IRWINWell, you know, being a central banker, there's an old line that it's like driving a car only by looking in the rearview mirror. They -- monetary policy works with long lag. So they have to not -- they have to look at the economic data and where the economy has been but then make decisions based on where the economy's going and project where it's going. Their view is that the economy is healing, you know, employment's rising, wages will start to rise, and if they don't start raising rates now that they'll have problems down the road.
BAKERI realize that thinking. You know, I've talked with many of these people, and, of course, you know, that is conventionally what they say. But I guess I'd make two points. One is we don't have stories where inflation just takes off, and we're suddenly looking at, you know, three, four, five percent inflation. All the models we have is the process is very, very gradual. The other point I'd make is we have to, again, keep track of where we are.
BAKERAnd workers took a huge hit in this downturn. If we go back from, you know, the '70s until, you know, the 2008 recession, the wage share of income remained pretty much constant. There are cyclical ups and downs, but if you take averages over a business cycle, very little change in the wage share over the cycle, the difference between wages and profits. In 2008, 2009, 2010, there's a huge shift from wages to profits that basically cost the average worker about six percent of their wages. I would like to see them get that back, and my view is if you let the unemployment rate continue to fall, let the economy continue to grow, then they would be in a position to get back the wages they lost in the downturn.
REHMHow do you respond, Doug?
HOLTZ-EAKINWell, I think that Neil's got the sort of thinking of the Fed exactly right. The hard thing for them on the data is how much of what we're seeing now is temporary and how much is really the trend, or relatively permanent? They've discounted a lot of the downward pressure on inflation and some of the slow economic growth due to international conditions and oil in particular and are saying that over the longer term those transitory factors go away, we have to get ahead of this before we make a mistake.
HOLTZ-EAKINI'm going to agree with Dean on the merits of having a tighter labor market. That's the single best thing that could happen in the United States, there's no doubt about it. I just don't think the Fed has the ability to do that. I think the Fed's overestimated its ability to generate growth as its kept rates down, and I think people are worried too much about what it'll do to growth as they raise rates. I think we need to be a lot more calm about this process.
REHMAll right, here's a question from our website. We've been on the longest near-free-money bender ever, but even so I suspect markets have already priced in future interest rate hikes. I'm interested in hearing what a rise in short-term rates will have on long-term rates, if any. But anyone with a retirement portfolio is probably worried just because they have no idea what's in store for them with this Fed. Neil?
IRWINSo that raises a really important point, which is, you know, when people find out I'm an economics writer or write about the Fed, they say, oh, when is the Fed going to raise rates, I need to, you know, lock in my mortgage or refinance my mortgage. It doesn't really work that way. You know, financial markets for long-term debt like mortgages, like treasury bonds, they price in the entire expectations of what's going to happen in the future with interest rates, with inflation.
IRWINSo the idea that we'll see some major swing in those kinds of rates that ordinary people face in the markets, on Wednesday after this rate increase, it's unlikely. You never know, markets can go up and down for all kinds of reasons, but there's no inherent reason to think that we'll see some huge disruption happen on Wednesday when they raise rates.
BAKERI'd mostly agree with Neil, and I'm not anticipating any huge disruption, but I will put in a qualifier here. If you go back to 2013, June of 2013, then Chair Ben Bernanke made a comment saying we will soon begin to taper our quantitative easing, our policy of buying bonds every month. To my view it shouldn't have been a surprise to anyone. I mean, everyone knew at some point they were going to start cutting back on their buying of bonds. It was -- it was not secret to anyone, it shouldn't certainly have been a secret to anyone in the financial markets.
BAKERNonetheless, there was this huge rise in interest rates. Long-term interest rates jumped by about a percentage point over the next month. So I'm not anticipating that. I'm just simply pointing out sometimes you get unexpected reactions.
HOLTZ-EAKINI'm sympathetic to Dean's point, but I think the Fed has learned from that lesson, and they have bent over backwards to make it clear to markets that they're going to raise rates, but they're going to very patient about it. So what you see out in the long end of the yield curve is an expectation that rates don't go up very fast. The second thing, just to remind everybody, is anytime you raise rates, for whatever reason, there are winners and losers without fail.
HOLTZ-EAKINAnd if you're a borrower, it's bad news, but if you're someone who's put your money in interest-sensitive, you know, bonds and things like that, you're going to benefit.
REHMAll right, let's open the phones, go to St. Louis, Missouri. Mike, you're on the air.
MIKEAnother great topic and one I've been kind of getting in on for a long time. You remember 1982, don't you, when we had a major recession?
MIKEInterest rates went up to like 20 percent. Well, I argued with friends at the time that we'll never see interest rates this high again and that the interest rates will trend down to -- and I even argued that mortgage rates will eventually go down to three and four percent, like they used to be. The truth is that we have had this deflation since 1982, and the workers of the world have felt it, whereas the people who manage money, who play with interest rates, have benefitted from the Federal Reserve essentially filling in this deflation, which has been going on since the early '80s.
MIKESo they propped up the market, and the equity was essentially transferred from working people to -- and real savers to the people (unintelligible) and then that came to an end in 2007, but we're now in the process of trying to essentially find out where the real bottom -- where real equity is in the marketplace.
IRWINYou know, there's something to that. You know, we think of the high rates of the '70s and '80s and to some degree the '90s as the normal state of things and that, you know, that a mortgage costs eight percent, and a 10-year treasury bond yields five or six percent. But if you look at a longer-time history, and I wrote this in the New York Times today, that's not necessarily the case. In an environment where there's low inflation, which has been the case for a lot of the last couple of centuries, you tend to have quite low interest rates.
IRWINAnd we're in this world now where the Fed, the European Central Bank, the Bank of Japan, they're all struggling to get inflation higher. They can't get the inflation they want. That implies that inflation is going to stay low for some time. If that's the case, there's no inherent reason that interest rates should spike back up to the levels they were at in the '90s or the '80s or the '70s. And maybe the new normal is actually the old normal, what prevailed in the '50s or the '20s, when rates were much lower than they were in the 1980s.
REHMInteresting. Dean Baker, you're still worried.
BAKERYeah, no, I largely agree with what Neil is saying, but I want to take that a step further. The conventional story, and certainly this is very much on the Fed's mind, that, you know, the reason you would raise rates is we're worried about inflation.
BAKERAnd that's a story of too little supply, too much demand. And Neil's point here, and again I don't want to put words in your mouth, is that we're facing a situation where we have too little demand, and as long as we have too little demand, you know, to my view the last thing you want to see is the Central Bank putting a foot on the brake.
HOLTZ-EAKINI don't think it's much of a break, and I do think it's important, as I said earlier, to distinguish between the inflation rate in services, which are largely not traded and which is what the Fed can pretty much control, that's a big chunk of the U.S. economy, it's the domestic economy over which it has the most influence, and that inflation they have been able to create. They're above the two percent target they're looking for. It's been very steady at 2.1 percent. So that's normal.
HOLTZ-EAKINThe unemployment is close to normal, and if you just looked at those things, you'd say why shouldn't monetary policy be normal instead of extraordinarily low. So I think there's a very good case to be made that they should be moving a little bit right now and continue to move.
HOLTZ-EAKINIt's the international part that they can't control, and that's why goods prices have been so low.
REHMAll right, to Artie in Indianapolis, you're on the air.
ARTIEIt's my understanding that the lesson we all learned from Paul Volcker in '80, '81, '82 is interest rates really have a minimal effect on either unemployment or growth and that it's principally the availability of excess reserves in the system and credit for (unintelligible) and as far as monetary policy is concerned. But that all belies another question, which is we're really in uncharted times in the fact that monetary policy is being asked to all the heavy lifting, and fiscal policy isn't doing its share.
HOLTZ-EAKINWell, I certainly would agree with the final comment. I mean, I think one of the reasons that the Fed's gotten so much attention is it's been the only show in town. There's a very good case to be made that we should've seen better tax and spending policies out of the Congress and the administration to help us grow. And hopefully that will be an agenda in our future. I'm not sure I took away the same lesson as the caller from the Volcker era. He put a very sharp spike in interest rates in as a matter of deliberately trying to slow inflation.
HOLTZ-EAKINThe economy reacted with a deep recession, and I think that potency of that channel is real.
BAKERYeah, well I'd agree very much with Doug that I think interest rates -- my takeaway from Volcker is interest rates mattered a great deal. But I just wanted to go back, you know, in terms of where we sit. Neil, and I appreciate Doug's points about, you know, the unemployment rate, but again I think if we take a broader measure of the labor market, you know, again look at employment rates, look at the quit rates, look at wage growth, you know, we don't see any evidence of inflation on that side.
BAKERAnd again, I understand the argument about services, but, you know, the Fed's measure is we take the core consumer price or GDP deflated for the consumption component, and that's well below two percent, 1.4 percent.
REHMAll right, here's an email from Kate that I think represents the voice of many people out there. She says, with a majority of wage earners earning less than $30,000 a year, how will raising interest rates affect our buying power, which is already too low? Neil?
IRWINWell, you know, this is a point Dean made earlier, which is that -- and Doug did, as well, that a low unemployment rate and allowing the economy to heat up and the labor market to get as strong as possible is the surest path toward higher wage increases and people being paid more. So to the degree that this rate increase is trying to slow that progress, that's bad news. Now, as Doug says, it's not a big move, it's not like this is going to radically slow the economy, but on the margins it certainly does slow things down.
REHMAnd many people are on the margins, living on the margins, Doug.
HOLTZ-EAKINBut the flip side, and the reason why this has been a struggle within the Fed and why there's a good debate today, is the idea of moving now is to cut off future inflation, which would undercut the ability of those same wage earners to buy. Right, their wages won't go as far. So it is...
REHMSo everybody is asking, if you haven't seen inflation in this period of time, how likely are you to see it.
HOLTZ-EAKINSo today, the Bureau of Labor Statistics released the Consumer Price Index for November, and we saw year-over-year, from November of last year to this year, a two percent increase in core inflation, right at the Fed's target. So the notion that somehow the Fed's jumping the gun I think is really overstated. You can debate about how much we know from the data now what it'll look like in the fall of 2016, but that's really the Fed's call. What do we want to look like in 2016 and then making the call that we need to start moving.
BAKERJust to be clear, their target is the consumption -- give me the term, the consumption...
HOLTZ-EAKINThe PCE deflator.
BAKERThe PCE deflator -- personal consumption expansion deflator. There we go.
HOLTZ-EAKINWe've dived straight into the weeds now.
BAKERAnyhow, that's 1.4 percent, not two percent, smaller point. But the way I put this is that, you know, the Fed's choice is we know we're going to raise unemployment by raising interest rates, and we might have an issue of inflation. So we're for certain making the job market worse. I don't mean this quarter-point hike but I mean the point of raising interest rates is to make the labor market worse in order to reduce the risk of inflation. And at the moment that seems a bad tradeoff to me.
REHMAnd you're listening to the Diane Rehm Show. Right now, I mean, are you questioning the idea that the Fed is moving now, Neil?
IRWINLook, yeah, this is a debate. I mean, the IMF has said they should wait. Some influential economists, Larry Summers has said they should wait. Some Fed officials have said they should wait, including two governors within the Board of Governors here in Washington.
IRWINYou know, there's a good argument that maybe there's a risk-management approach for waiting. Maybe what you want to do is let the economy overheat a little bit, wait until you see the whites of the eyes of inflation and then raise rates. I think what Janet Yellen, the chair, is saying is no, we're actually better off if we gradually move rates up a little bit and avoid having to tighten faster later, which could cause financial disruptions and all kinds of problems down the road. So she's making a risk-management argument from the other direction.
REHMSo how does that strike you?
HOLTZ-EAKINWell, you know, again, to my view we have such small risk of inflation, it just seems to me that, you know, it's taking the wrong move. And again, I want to be clear the quarter point's not a big deal. I think what, you know, all of us here I think are going to be looking at is what is the statement. So when we see on Wednesday they're going to raise the rate a quarter point, they're going to issue a statement, and to my view the big thing is are they going to say we're on a path towards raising rates so that, you know, say every other meeting...
REHMOkay, so if she doesn't say that, then what?
IRWINI think it'll be interesting to see just, you know, how they characterize the strength of the economy. That's going to be the key for the pace of the rate increases. But remember...
REHMSo what are the words you want to hear?
IRWINBefore I answer that question, I just want to emphasize, there's a reason why doing nothing is also risky and why there's push to start normalizing interest rates. The Fed doesn't just look at two numbers, an inflation rate and an unemployment rate, it looks at broad indicators of financial stability, and it's worried a little bit about what looks like commercial real estate bubbles. It's worried about what's going on in junk bonds. It's -- and by moving rates to a more normal level, it thinks it can run off potential difficulties coming out of those areas that would then turn around and really harm the labor market, which is what obviously everyone in the end cares about.
BAKERWell then it's, you know, I'm the one who yells about bubbles. I take the problem of bubbles very, very seriously. But I think dealing with that by raising interest rates is a really bad way to go. I would say last summer, Chair Yellen, Chairman Yellen, Chairperson Yellen, in her testimony, made a point of highlighting sectors of the economy where she thought there were bubbles, and she produced data from the Fed to support that.
BAKERAnd it had exactly the effect she intended. She was pointing at the junk bond market. She was pointing at some biotech companies. All those prices fell in the week immediately following it.
BAKERThat's what I would like to see her do as a first step, if she's worried about bubbles.
REHMWhat do you expect to hear her say tomorrow, Neil?
IRWINWell, you know, these words are very carefully measured.
REHMVery carefully calibrated.
IRWINIf she talks about a measured pace for rate increase or something along those lines, that would be a sign that they're going to move very carefully, very gradually.
REHMVery slowly, and is that what you expect?
IRWINI think in some form, yes.
REHMIs that what you hope for?
BAKERWell, very gradually or perhaps not at all. Again, if they follow the data, and, you know, my view of the economy I think is weaker than many, you know, certainly at the Fed think. And if the economy looks weak, I hope we don't see any more rate hikes for some time.
REHMAnd what do you hope to hear?
HOLTZ-EAKINI hope to hear exactly what Neil characterized, you know, we're going to raise rates at a measured pace, and it's going to be done consistent with the data as it comes in.
HOLTZ-EAKINAnd that's probably what she'll say.
REHMWe're going to leave it there. Douglas Holtz-Eakin, Dean Baker, Neil Irwin, I want to thank you all and once again to apologize to our listeners for the technical difficulties we've had in this hour. But we'll be talking more about the economy as the year and next year move on. Thanks for listening, all. I'm Diane Rehm.
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