rate hike

Interest Rate Increases Are Hard to Undo?

Interest Rate Increases Are Hard to Undo?

During her Congressional testimony today, Chair Yellen made the following statement, ”I do not expect that the FOMC [Federal Open Market Committee] is going to be soon in the situation where it is necessary to cut rates.”  In this post, I argue that her statement suggests that the FOMC’s policy moves will be inappropriately insensitive to adverse information about the evolution of the economy. 

The FOMC is clearly leaving open the possibility that it will not raise rates in March.  (Markets seem to see that as the most likely outcome right now.) That means that there’s some set of economic conditions for which a range of a quarter to half a percent for the target range for the fed funds rate is appropriate.  Under an appropriately data-sensitive approach to policy, the FOMC should slightly lower the fed funds rate target range if it confronts a slightly worse set of economic conditions.    

There is a sense in which the above is exaggerated – after all, the Committee doesn’t (and probably shouldn’t) make moves smaller than a quarter percentage point.  For that reason, it requires more than slightly worse economic conditions to lower rates by the requisite quarter percent.   But – as we heard from many commentators in December – a 25 basis point move is still pretty small.  With that in mind: If a move of zero is highly likely, surely a downward move of a quarter percent point should be more than a little possible?

But Chair Yellen’s statement suggests that this isn’t the way that the FOMC is thinking about the situation.  Instead, she seems to be saying that it will take a pretty bad turn of events for the FOMC to be willing to reverse its December move.  Such an approach means that the FOMC’s December has created a new higher floor for the interest rate on excess reserves.  That new floor is certainly softer than the old one – but it’s a floor nonetheless.

There are a couple of different responses to this commentary.  The first (and better) response is the FOMC could be a lot more data-sensitive than I’ve described when it considers interest rate cuts.  

Failing that, the other response is to realize that any future rate increase will push upwards on the new soft floor.  That realization should make the FOMC very cautious about undertaking any future rate increase.

N. Kocherlakota

Rochester, NY, February 10, 2016

Please address media enquiries and non-academic speaking requests to Monique Patenaude (monique.patenaude@rochester.edu and 585-276-3693).

Thoughts on Policy 

Economic Policy Page

Kocherlakota Main Page

rate hike

rate hike


Saved Articles

The Life and Career of Charlie Munger

Charlie is more than just Warren Buffett’s friend and Berkshire Hathaway’s Vice Chairman – Buffett has actually credited him with redefining how he looks at investing. Now you can learn from Charlie firsthand via this incredible ebook and over a dozen other famous investor studies by signing up below:

  • Learn from the best and forever change your investing perspective
  • One incredible tidbit of knowledge after another in the page-turning masterpiece of a book
  • Discover the secrets to Charlie’s success and how to apply it to your investing
Never Miss A Story!
Subscribe to ValueWalk Newsletter. We respect your privacy.

Congrats! Are you a smart person?

We have an exclusive targeted & limited time offer for being a sophisticated and loyal reader.

ValueWalkPremium is a website and newsletter on the latest industry news much of which is not in the public domain and obtained via our sources.

We also have 10 years of resources on how to use this information to better your investment process.

Sign up for  today and get our exclusive content for 40% off. This is our second biggest discount ever!!

Use coupon code VIP20 or click on the button below

Limited time offer only ENDS 2/29/2019 or after next 25 subscribers take advantage whichever comes first – please do not share this discount with others