Tags: Lahart | shadow | Fed | rates

WSJ's Lahart: Impact of Rising Rates 'Could Be Harsher' Than Expected

By    |   Thursday, 04 September 2014 11:36 AM

Most economists expect the Federal Reserve to raise interest rates gradually, and many predict the effect on financial markets will be muted.

But Wall Street Journal columnist Justin Lahart warns they may be wrong. "The impact of rising U.S. interest rates on financial markets could be harsher, and come sooner, than investors are ready for," he writes

Economists Jing Cynthia Wu of the University of Chicago and Fan Dora Xia of Bank of America have created a shadow federal funds rate. They use long-term Treasury yields to determine the shadow rate.

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As of July, it was negative 2.8 percent. "As the date of the Fed's first rate increase approaches, longer-term interest rates should begin to adjust, bringing the shadow rate back in line with the fed funds rate," he writes.

"So if the Fed were to raise its target range to 0.25 to 0.5 percent, that would entail a 3-percentage-point increase in the shadow rate in less than a year. That would exceed the pace of tightening seen in 1994, which was less than kind to the stock and, especially, bond markets," Lahart explains.

"The large gap the shadow rate must traverse before it gets to zero amounts to an argument for the central bank being clearer sooner about when its rate-rise countdown is beginning. And it must be prepared to adjust the timing of its move if this casts a shadow over the economy."

Meanwhile, the private sector's reluctance to part with its cash has prevented the Fed's easing from helping the economy more, say St. Louis Fed Bank researchers Yi Wen and Maria Arias.

"So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP?" they write on the bank's website. "The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it."

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Finance
Most economists expect the Federal Reserve to raise interest rates gradually, and many predict the effect on financial markets will be muted.
Lahart, shadow, Fed, rates
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2014-36-04
Thursday, 04 September 2014 11:36 AM
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