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In itself a rise might seem unimportant. The Fed’s intervention rate has been 0.25 per cent since December 2008. One must doubt whether a jump to 0.5 per cent would be significant. After all, the Bank of England’s base rate has been 0.5 per cent throughout the crisis. This point is correct, but too limited.
Any increase would be significant: first, it would indicate the Fed’s belief that the policy can be “normalised” after almost seven years of post-crisis healing; second, it would indicate the beginning of a tightening cycle.
One of the reasons for believing the latter is that this is how the Fed has historically behaved: the last such cycle began with rates at 1 per cent in June 2004 and ended with rates at 5.25 per cent two years later.
Without doubt, beginning a tightening cycle for the first time in more than 11 years would be a significant moment. It would also signal more than an immediate rise in rates.
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In sum, central banks should continue to focus on stabilising the real economy, though more needs to be done to curb financial excesses. Meanwhile, as an inflation-targeting central bank, the Fed has no strong reason to start a tightening cycle right now. And, when it does start, rates will not reach previous cyclical highs. Our world is not normal. Get used to it.
Full article on Financial Times (subscription required)