Fed hike is a brave experiment

A vote of confidence.

That’s what people are calling today’s move on interest rates by the U.S. Federal Reserve. The quarter-point uptick is the first hike since the start of the financial crisis.

But is it confidence, or simply a response to longstanding concerns that leaving rates at a mere 25 basis points above the zero mark has made the U.S. appear economically weak for far too long?

Read: What Yellen’s move means for investors

In truth, it’s a bit of both.

Federal Reserve chair Janet Yellen did the right thing today, even if the rate increase takes some short-term wind out of the sails of a U.S. recovery. She was equally right to mark the first years of her term as Fed chief as an inflation dove, and patiently allow the U.S. unemployment rate to drift down to 5%.

Biding her time let the central bank unwind some of its QE measures (which in many ways were more worrisome than sustained low rates). That same waiting game was expected to allow inflation rates to recover to normal levels of around 2% and put the Fed’s governors back into their usual, and more comfortable, roles as inflation hawks.

That didn’t happen. President Obama, and both of his Fed chiefs, has been forced to contend with a jobless recovery—the length of which far outstrips the one Bill Clinton and Alan Greenspan faced in the 1990s. While unemployment is now 5%, economists and labour experts, as well as the Fed chief herself in comments today, have raised concerns about the quality of jobs that have been created since 2008, versus those that left the economy.

Further, a strengthening U.S. dollar has cut into retail prices for imported goods and kept inflation well below the Fed’s 2% target.

Read: Bulls, bears and contango: What’s in store for crude

In that context, today’s move is an attempt by U.S. central bankers to find a way to remain relevant; and, more importantly, to keep the concept of central banking relevant at a time when most of the world’s developed economies remain in the doldrums.

Charged with striking a balance between employment levels and inflation rates, central bankers pine for the days when benchmark rates hovered in the 4% range and they held the tools necessary to keep recessions shallow or shorten their durations.

Yellen and the Fed’s governors decided to tinker today because the U.S. economy is the best it’s been in a long, long time. So, while the statistics suggest a rate hike isn’t ideal right now, there’s also a compelling need to see if the tools central bankers wield still hold any power to affect change.

Read: BoC watching bond market liquidity

Today’s mild hike won’t be destructive, even to an economy that hasn’t completely regained its legs. The worst consequence would likely be a need to retreat to 0.25% sometime during the coming year. The U.S. has been there before, and the risk of letting its central bank remain impotent for years to come is far greater.

During his tenure as Fed chair, Ben Bernanke stressed the need to learn from the massive policy errors made during the Great Depression. It now falls to Yellen to ensure the U.S. doesn’t repeat the mistakes of Japan.

---

Philip Porado is a veteran Toronto-based journalist who specializes in financial and business topics. Prior to immigrating to Canada in 2004, he covered brokerage compliance, real estate, housing policy, architecture and technology for several U.S. publications.