What the Fed’s Interest Rate Hike Could Mean for Your Paycheck
The Federal Reserve’s recent decision to boost short-term interest rates by another 0.25% has led to the usual round of carping among second-guessing, central banker wannabes. But with unemployment dropping to 4.3% and the economy still growing at its “new normal” of 1 to 2%, why shouldn’t the Fed raise rates?
Critics answer that so long as inflation remains tame, the Fed shouldn’t take away the punch bowl and should keep the credit party going at least until hitting its inflation target. This argument ignores risks in accommodative monetary policy of far greater concern than whether core inflation goes north of 2%. Cheap interest rates are designed to spur economic activity by encouraging more borrowing. This was a questionable policy choice to begin with, given the role of excessive leverage in fueling the 2007–08 financial crisis. America has been doubling down on it with a zero interest rate policy for eight years.
Cheap credit leads to increasing levels of debt and destabilizing asset bubbles—be they mortgages pre-2008 or primarily financial assets now. Given the miserable failure of low interest rates to raise worker’s real wages, if anything, the Fed should be setting targets for deflation. (I’m only half-kidding.)
There are two ways to achieve real wage growth: Get employers to give their workers wage increases that will outpace inflation—difficult given low productivity gains and structural changes in the workforce— or let consumer prices fall a bit to give workers more purchasing power. A little deflation is not a bad thing if it is the result of increased competition and technological innovation. The Fed should be celebrating, not fighting, lower prices for cars, cell phones, and clothing. Raising the inflation target, as Fed Chair Janet Yellen recently hinted, would simply lower living standards for workers and shift more wealth to those who derive their income from financial assets.
The Fed’s small adjustments in interest rates are necessary. If done slowly and incrementally, they should impose little pain. Borrowers will see slight interest rate increases on credit cards and variable rate mortgages, while savers will see welcome increases in interest rates on their certificates of deposit and bonds. Yes, banks will benefit by being able to charge more on their loans, as the Fed’s critics are eager to point out. But among banks, community and regional banks have suffered the most from the zero interest rate policy and will benefit most by rates rising. Big banks will also benefit, but then they also benefited from declining rates, realizing gains in their securities holdings and reaping fees from the massive level of corporate debt issuance spawned by zero interest rates. (Let’s face it: Big banks make money no matter what.)
These small interest rate increases are a cause for celebration if they eventually bring America back to a vaunted time when saving was celebrated, working families and retirees could get a reasonable return on their savings, and borrowing was something that people did only if they really had to. The U.S.’s declining savings culture has coincided with policy shifts that rely on low interest rates and government debt subsidies to foster economic growth. America needs to make credit a bit more expensive in its debt-laden economy. And monetary policy needs to focus more on system stability and less on increasing inflation.
Sheila Bair is president of Washington College and was chair of the Federal Deposit Insurance Corporation from 2006 to 2011.