Is the Fed dong the right thing by not increasing the interest rates??

Is the Fed dong the right thing by not increasing the interest rates?? 

Foreign Portfolio Investments (FPI) have been negative in the last two months, yet the RBI has decided to toss for growth and lowered the rates by 50 basis points. The uncertainty regarding the Fed interest rate hikes remains today with added worry that funds moving out once lower rates in India are juxtaposed with higher rates overseas.

Like RBI most central banks around the world are looking at the Fed on when it will increase its rate and how they should shield their economy with the appropriate adjustment in interest rates, the time has come when the Fed must normalize interest rates or risk a collapse into crisis.

It has been nearly two years of dithering since the Fed began to taper its bond purchase programme — a move some thought would presage a swift tightening of policy. Hope had soared that the September 16-17 FOMC meeting would bring an announcement of the first interest rate rise since June 2006, although to say the time had come was offensive to any casual market observer witnessing financial markets’ acute vulnerability.

The truth is the time has probably come and gone. But that should not have swayed Fed policymakers. The evidence is abundant that the ability of monetary policy to spur economic growth is exhausted.

More concerning are increasing distortions in an economy and financial system that threaten to collapse into crisis. The financial markets may not be fully on board with rising interest rates, but any further kowtowing to investors’ promises to strip the Fed of its last vestige of credibility. Financial stability has crept in as a de facto third mandate, but the meaning has been perverted since former Fed chairman Alan Greenspan first cut interest rates to prop up financial markets in 1987. Stable has become a euphemism for buoyant as it pertains to risky assets, the home of runaway inflation.

 In the meantime Fed policy has facilitated bad behavior. Corporate chieftains, a breed long plagued with shortterm-itis, have been encouraged to trespass further by the siren call of cheap money. Why bother investing in the long term when it is so much more fun, to say nothing of more lucrative, to buy back shares, reduce share count and puff up profits?

The build-up in capacity across a wide swath of industries is also damaging. The corporate bond market has not suffered a full default rate cycle in generations; such is the fear of policymakers of allowing market forces to weed out the chaff from the viable wheat. Is it any wonder capacity utilization has yet to recapture its 30-year average of 79.5 per cent?

At least many companies have taken advantage of this unprecedented era of low interest rates to extend the maturity of debt on their balance sheets, insuring against potential damage the next time capital markets seize up.

Many developed and developing countries have similarly indemnified their nations’ balance sheets against another global recession by issuing 50-year or 100-year bonds. If only the same could be said of the US Treasury. Instead the US government continues to borrow short term — as if the world were going to end tomorrow.

The Fed deludes itself with manufactured inflation metrics that insult the average US household buckling under the strain of untenable healthcare burdens, runaway housing costs and steep higher-education expenses. Its other formal mandate, to maximize employment, necessarily runs counter to maintaining price stability. Easy monetary policy has been along for a nice ride back to a low rate of unemployment but the numbers say so little. What does a 5.1 per cent unemployment rate mean when the labor force participation rate is near a 40-year low?

Model-driven monetary policy that constantly redefines itself by reducing the requisite unemployment rate and ignoring rising inflation will not succeed. Meanwhile excesses continue to build in the global financial system; pensioners and savers are more exposed than ever to inappropriately risky investments. Normalize interest rates and reinstate the incentive to save. Introduce a generation of millennials to the sensation of earning interest. Might the interim be harsh, could be possibly. But the alternative, lower for longer yet, is a price the country can ill-afford to pay again.

Members of the FOMC call a press conference at the conclusion of the October meeting and give the US a gift that, in time, can keep giving. Own up to the fact that not taking action is more harmful to the country and the world economy on the whole than finally taking a stand and acting in its best interests.

_ Farzan Ghadially