Stark contrasts in views about when the Fed will hike rates
By Greg Robb, MarketWatch
WASHINGTON (MarketWatch) -- There is a wide range of opinions among Fed watchers about when the central bank will begin to hike interest rates and unwind its unprecedented credit-easing policy.
In order to shed light -- and not heat -- on the debate, MarketWatch has asked two prominent economists to discuss their opposing views on monetary policy.
The participants:
Ken Mayland, the president of Clearview Economics LLC, and previously chief economist with First Pennsylvania and KeyCorp.
Avery Shenfeld, managing director and senior economist with CIBC World Markets. Shenfeld has been with the Montreal-based firm since 1993.
Mayland believes the Fed will first hike rates in the first quarter of next year. On the opposite side of the spectrum is Shenfeld, who thinks the Fed will hold off hiking rates until 2011.
We started the debate by asking Mayland why he thinks the Fed will move soon.
Mayland: They don't need to do it in early November, or even at the mid-December FOMC meeting. But, once the economy is clearly getting traction, like what we saw in the third quarter, it is time to tighten.
Right now, there is an extraordinary amount of liquidity residing on banks' balance sheets as "cash," which is mostly benign. But this cash, or if we think in terms of monetary aggregate, the adjusted monetary base, represents fuel, which could generate a massive monetary expansion.
I'm of the school that inflation "always and everywhere" results from too much money chasing too few goods.
Shenfeld: I'm not entirely opposed to beginning to reverse some of the Fed's quantitative easing in the early part of the new year. While that in a technical sense is a "tightening," from a practical view it wouldn't really constitute a policy shift.
A true tightening, in the more conventional sense, would be to move away from the near-zero target rate on fed funds. We are a long way from the type of economic conditions that typically prompt the start of a tightening cycle
This was a much more serious downturn. Nor are there any signs of inflationary pressures.
The Fed can't simply look at economic growth in timing the first rate hikes. It also has to dissect the ability of the economic party to continue after it starts to take the punchbowl away.
I challenge you, then, to make the case that the current momentum we've seen would be self-sustaining even with interest-rate hikes and, down the road, the end of extraordinary fiscal stimulus.
Mayland: Well, we have started to agree on something: draining the excess liquidity ... but how much? I suspect that with draining even a moderate amount of excess liquidity, and eliminating the alphabet-soup market-assistance programs, it will prove difficult to hold the fed funds rate to 16 basis points.
True, in the past, tightening happened years after recession ended -- but this time is different, coming from an emergency rate of near-zero. Let's face it: A rate of 1% or even 2% is still extremely low. I don't think the Fed should have lowered the fed funds rate to zero in the first place. A prime rate of 4% or 5% will not derail this recovery.
I take issue with your view that there are "no signs of inflation." The U.S. economy has never seen this amount of monetary-base growth! Excessive money growth can trump the slack argument.
Concerning the sustainability of the recovery, I would note the following: Recoveries are always caused by "the 90%" -- those that remained employed -- lowering their saving rate -- as is happening now.
Two of the easiest forecasts in the world to make right now are higher housing starts and light vehicle sales. Why? Because they are so far in the dumps that the only direction is up.
Exports will be a significant driver, due to the world recovery and a very cheap U.S. dollar.
Inventories are going to prove to be quite a dynamic force for recovery, as current production is running far short of current demands; just bringing production up to current demands would generate 4% GDP growth, spread over some period.
Capital spending on equipment appears to have made its turn.
I don't particularly like the $800 billion stimulus plan, but I cannot ignore its macroeconomic impacts. It will continue to unfold for several more quarters.
