When the time comes for the US Federal Reserve and other central banks to ward off inflation by boosting interest rates from the current super-low levels, they shouldn’t hesitate, an economist and expert on monetary policy said on Saturday.
Even though the US and the global economy are healing from the worst recession since the 1930s, many economists think it will be a while before central banks start lifting rates. In the US, economists think the Fed won’t begin pushing up rates until next summer.
Still, when that decision is made, interest rates will need to be “increased aggressively,” said Carl Walsh, professor at the University of California, Santa Cruz, when discussing a paper he presented on the topic at the final day of an annual Fed conference in California.
“Committing to a gradual increase in the policy rate is not justified,” he said.
Consumers, businesses and investors, he argued, must feel more confident that prices won’t spiral higher in the future. Or as Walsh put it, so that their inflation expectations don’t become “unanchored.”
The high-stakes matter of when and how the Fed should start boosting record low interest rates and reel in the trillions of dollars it has pumped into the financial system came up frequently during discussions at the conference.
Timing is vital: Act too fast, and the Fed risks choking off lending to businesses and everyday Americans; wait too long, and it risks setting off crippling inflation.
Jean-Claude Trichet, president of the European Central Bank, however, favors a “steady-handed” approach in moving rates.
“A gradualist approach of this kind may be the most effective antidote to the threat of price stability,” he told the conference.
Although some participants seemed to have mixed thoughts on how quickly the Fed would need to push up rates once it starts tightening, many agreed that it would be critical for the Fed to communicate its intentions clearly to avoid confusion and jolts to financial markets.
Earlier this month, the Fed left the target range for its bank lending rate at zero to 0.25 percent. And it pledged to keep it there for an extended period to help nurture an economic recovery.
The rationale: Super-cheap lending will lead Americans to spend more, which will support the economy.
If the Fed holds rates steady, commercial banks’ prime lending rate will stay at about 3.25 percent, the lowest in decades. That rate is used as a peg for rates on home equity loans, certain credit cards and other consumer loans.
To battle the recession, the Fed and other central banks around the world have slashed interest rates to near zero and rolled out a number of extraordinary programs to get credit flowing again and to stabilize financial markets.