Tags: federal reserve | interest rate | exit | policy

The Fed Exit Conundrum

By    |   Thursday, 26 February 2015 07:13 AM EST

“It’s easier to get into something than it is to get out of it.”

The above phrase was uttered several years ago by former Defense Secretary Donald Rumsfeld regarding military intervention. But the phrase is just as true in terms of the Federal Reserve Bank’s large scale involvement in the economy.

Since the last recession, the Fed has injected more than $4 trillion into the banking system with its quantitative easing programs (QE) and, at the same time, held interest rates to historic all time low levels for more than six years now. That was the easy part.

The markets, and the general public for that matter, are OK with the Fed injecting the system with newly printed money in a way that props up stock and asset prices.

Few get nasty when the Fed lowers rates and makes it cheaper to get a mortgage and borrow money. It wasn’t all that difficult for central bankers to be the heroes that support the market and the economy during tough times.

But reversing policy will be quite another story.

We got a taste of the difficulty the Fed will have this week. Markets breathed a sigh of relieve earlier this week. The Fed released minutes from the January 27-28 meeting that indicated that the central bank might not necessarily be in too much of a hurry to raise rates at this point unless things change.

Wall Street interpreted this banker drivel to indicate that the Fed is less likely to begin raising rates in June. This was seen as good news and the markets closed near all time highs again.

Several noteworthy economists have also weighed in that the Fed needs to be very careful not to raise rates too fast. June would be too early, they warn, because of the still fragile state of the global economy.

Let’s put this in perspective. The Fed lowered the discount rate to the current near zero level in 2008 in order to stave off a possible depression. Now, we’re six years into a recovery with the economy strengthening and the Fed is finding it you too risky to raise the rate from say 0.16% to 0.66%. The historic average for the discount rate is over 4%.

The Fed is finding it too darn difficult to make this small and long overdue adjustment to short term rates that likely won’t even have any lasting negative effect on the market. Will the Fed be able to make the much more painful rate hikes down the road that might be necessary to fend off inflation? I doubt it.

The problem is that the Fed, along with central banks all over the world, has replaced market forces in determining interest rates. Markets react quickly in real time and, good or bad, adjustments are made and quickly adsorbed by the markets and the economy. But central banks are in a position hard choices are premeditated and have to be made voluntarily.

It’s like breaking your arm. I’ve broken my arm as a kid. It wasn’t that terrible. But imagine if you had to volunteer to have your arm broken and show up to have it done at a predetermined place and time. That would be truly excruciating.

It’s perfectly human to avoid unpleasant actions. But central banks are in a position where their behavior must be unnatural and defy gravity. Central banks all over the world have lowered rates to all-time lows.

Should it become necessary to start raising rates in the future to fend off possible inflation, it is unlikely they will muster the will to do so.

It may not seem like a problem right now. But the future holds great peril for central bank’s inability to reverse course.

About the Author: Tom Hutchinson
Tom Hutchinson is a member of the Newsmax Financial Brain Trust. Click Here to read more of his articles. He is also the editor of The High Income Factor. Discover more by Clicking Here Now.

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The future holds great peril for central bank’s inability to reverse course.
federal reserve, interest rate, exit, policy
Thursday, 26 February 2015 07:13 AM
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