The chair of the Federal Reserve Janet Yellen has announced a small but policy significant increase in their targeted range for interest rates from 0.25% to 0.50 % to 0.5% to 0.75%.
The over night funds rate sits at 0.41% and the Federal reserve open market committee also approved a quarter point rise in the discount rate raising the primary credit rate from 1% to 1.25% points. It also indicated that future rate rises would be “data determined” and gradual over the coming year. The stock market has initially reacted negatively although that may well turn out to be a 24-hour wonder.But there is a more serious issue. Is the US recovery strong enough and the risk of price inflation real enough to justify even this small increase in rates? Some analysts and bankers are convinced.I’m not so sure. That will be the key issue in the months going forward. Keeping the interest rates low enough to accommodate the infrastructure and deficit spending that is part of the Trump strategy going forward should be a top priority. The economy is still quite vulnerable to a set back and discouraged worker unemployment still significant. Low interest rates are a necessary but not sufficient condition of robust economic growth. We are going to see if the Fed has learned the importance of this key insight in the near future. From a Canadian point of view this rate rise may well put pressure on the Bank of Canada to raise rates as well, They should resist the temptation to do so.
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