Sunday, September 18, 2005

A real dilemma

If you're one of those people who expects the U.S. Federal Reserve to stop raising interest rates next week then you probably don't look at enough charts.

If you were to look at the charts the Fed looks at then you would understand why to stop raising interest rates now would defeat the purpose of the past 12 months of rate hikes.

One piece of data the Fed takes very seriously is the real interest rate; the interest earned on overnight deposits after taking account of inflation (i.e. higher inflation means lower real interest).

Going up

What the chart shows is that real interest rates are currently zero. Putting $1 in your bank account today will earn no interest in real terms. Your dollar today buys you less tomorrow. That's not going to help anyone, including those who survived the hurricane.

What the Fed is aiming towards is a neutral real interest rate. Judging from the past that means we should expect at least another 2% of interest rate hikes by the Fed (measured, not stirred).


Nothing can stand in the way of the Fed on a mission, not even a hurricane. When the time is right, interest rates will stop going higher. If history is anything to go by, that usually means they're ready to head in the opposite direction.

1 comment:

gavstrainers said...
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