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Case for US rate hike 'has strengthened'

August 26, 2016

An improved outlook for the US economy and solid job creation have bolstered the case for raising interest rates, the chair of the US central bank has said. But she did not indicate any specific timeframe for the move.

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USA FED Pressekonferenz Janet Yellen
Image: Reuters/J. Ernst

Federal Reserve Chair Janet Yellen said on Friday the Fed is moving toward raising interest rates in light of a solid job market and an improved outlook for the US economy and inflation.

But she stopped short of signaling any timetable for the next rate hike. Her comments reinforced the view that such a move could come later this year. The Fed has policy meetings scheduled in September, November and December.

Speaking at a three-day international gathering of central bankers in Jackson Hole, Wyoming, Yellen said the "US economy was nearing the Federal Reserve's statutory goals of maximum employment and price stability."

"In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months," Yellen said in prepared remarks.

She added that the Fed still thinks future rate increases should be "gradual."

Under the title Designing Resilient Monetary Policy Frameworks for the Future, Yellen and her fellow central bankers, among them Europe's Mario Draghi, Japan's Haruhiko Kuroda and Britain's Mark Carney, are discussing strategies on how to create long-term growth in a low-interest and low-inflation environment.

In the wake of the 2007-2009 financial crisis and recession, central banks across the industrialized world have cut interest rates to zero and beyond and pumped trillions of dollars and euros into the global financial system hoping their policies would cut the cost of credit and spur growth as well as productivity.

Frankfurt Stock Exchange
Ultra-low interest rates in the wake of the financial crisis have caused stock and property prices to soar but failed to kickstart growth in the world's major economies.Image: Reuters

Longing to return to 'normal'

Post-crisis monetary policies have remained in place for almost a decade now - much to the surprise of central bankers, including Yellen, who have expected world economies to return to a pre-crisis "normal" once the dust has settled after the turmoil.

Instead, the emerging vision is of a changed world where expected growth is lower, deflation remains more of a risk than rising prices and businesses hesitate to invest. In view of those woes, consumers have remained cautious adding to current uncertainty about a consumption boost to growth.

Moreover, governments have ignored the pleas of central bankers to reform their economies amid the low-rate environment, and continue refusing to ditch their austerity programs in support of productivity-enhancing investment.

As a result, the debate at Jackson Hole, which will be carried out in technical research and policy forums, could herald a break with decades of central bank orthodoxy which has relied on short-term interest rates as the main policy lever.

Randy Kroszner, a former Fed governor and now an economics professor at the University of Chicago Booth School of Business, said that back in 2009 no central banker would have though that that historically low rates "for some time" would mean "six, seven, eight years later."

"If central banks are being asked to do some longer-run kinds of things, what is the right framework...what is the balance sheet, what are your targets, what are the tools?" he told the news agency Reuters.

It is a revolutionary question, suggesting monetary policy works in the short run, and does not have an impact on long-term growth and productivity dynamics.

Negative for longer?

Negative interest rates have become part of crisis policy in Europe and Japan, but mainstream economists are beginning to pave the way for them to become permanent policy options. Negative rates mean that commercial banks must pay to keep their funds on deposits with a central bank. The aim is to encourage commercial banks to lend money or invest it in riskier assets.

Some $8 trillion (7.1 trillion euros) of sovereign debt has negative yields and central banks across the globe own $25 trillion of financial assets - a sum larger than the economic output of Japan and the United States combined - according to Bank of America research.

Discussion has even turned to whether central banks should drastically scale back the amount of physical cash in circulation so mattress-stuffing and massive withdrawals can't be used as a way to blunt the effectiveness of negative rates.

But there's also a sense that the good old days may not come back.

Fathom Consulting deemed it "the end of monetary policy," while Goldman Sachs analysts David Mericle and Daan Struyven said that as it stands central bankers may be painted into a corner.

Quantitative easing may not work in any future crisis, and if markets have lost faith in the Fed, forward guidance won't either. "These concerns might well be a key theme both at Jackson Hole and in Fed commentary in the coming year," they wrote.

uhe, sri/hg (Reuters, dpa, AFP)