Will the Fed Raise Interest Rates? Kristen Fanarakis

SMITH BRAIN TRUST — Kristen Fanarakis is the assistant director of the Center for Financial Policy at the Robert H. Smith School of Business.

Q: What is the likelihood that the Fed will raise rates in September? If it does raise rates, by how much will it do so?

A: Given the aggressive sell-off we've seen in stock markets over the past week, a September hike is looking less and less likely. Though the sell-off is driven more by China growth concerns and not by the fear of the Fed hiking rates, it seems more likely they would push off to later in the year to assess the state of the economy.

Q: What are the risks of not raising rates? Or, what are the risks of raising rates prematurely?

A:  With rates at historically low levels, the risks of not raising interest rates lies in not having much ammunition left in the monetary chest should the economy take another downturn, something this recent bout of volatility in the markets underscores. A modest 25 basis-point hike (0.25 percent) would give the Fed some cushion they likely want to have should we see another dip, and remove some of the ongoing speculation that has consumed markets since the 2013 taper tantrum in the wake of Chairman Bernanke’s comments.  

Above all else, financial markets desire certainty.  Dragging out this “will they or won’t they” debate could ultimately do more harm than if they simply pulled the trigger. Inflation is under control and growth isn't exactly skyrocketing, so no one is expecting them to embark on a series of hikes. Though if they do raise rates, December seems more likely given recent market turmoil.

Q: What are the strongest statistical/economic indicators that it is time to end the nine-year period of ultra-low rates? Or: what data counsels holding off on a policy shift?

A:  The Fed is mandated to create maximum employment, keep inflation under control and maintain moderate long-term interest rates (the first two commonly known as the Fed's "dual mandate.") The PCE (personal consumption expenditure) index is the measure the Fed watches has been under its 2 percent target for more than 3 years. Economic growth is around 2 to 2.5 percent, below our long-term average, which is closer to 4 percent, but healthy enough. The state of the labor market has been a point of contention among economists as the unemployment rate has dropped, but primarily due to people dropping out of the labor force.  

By those measures it isn't clear that it's time to hike, but extended periods of low interest rates can create distortions in financial markets and excessive risk taking. I think that is the Fed's biggest concern, again, along with the worry that with rates already near zero they aren't well equipped to deal with another economic downturn.  

Monetary policy has had to do all the heavy lifting since the crisis in terms of supporting economic growth. The Administration and Congress have clearly demonstrated that they aren't prepared to support the economy through effective fiscal policy or by dialing back regulations. A 25 bp hike would give the Fed some breathing room should they have to pick up the economic stimulus slack — again.