PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENEURSHIP

The Rate Hike: The Sky Won’t Fall, But the Fed’s Rationale is Concerning

By at 14 December, 2016, 5:39 pm

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by Raymond J. Keating-

So, on December 14, the Federal Open Market Committee raised the federal funds rate from the 0.25%-0.5% range to the 0.5%-0.75% range. And guess what? The sky didn’t fall.

Should small businesses care? Well, yes and no. Consider a few key points.

First, it’s important to recognize that the fed funds rate remains at historic lows. Since late 2008, this short-term interest rate targeted by the Fed has been pushed down to levels never seen before. The announcement of this tiny increase in a tiny interest rate level amounts to no effective change in monetary policy.

Indeed, the FOMC statement explicitly said: “The stance of monetary policy remains accommodative…” To say the least.

Therefore, the true immediate risk regarding monetary policy is not how this small increase might affect borrowing, but how eight years of loose money without precedent will shake out in the end.

Second, the reasons for this rate increase do not exactly inspire faith that the Fed knows what it’s doing, or that it is reading the economy correctly. For example, the FOMC statement said: “Job gains have been solid in recent months and the unemployment rate has declined.” Adding to that, Fed Chairwoman Janet Yellen said, according to MarketWatch.com, in her press conference: “I would say the labor market looks a lot like the way it did before the recession.”

That’s a stunning comment given how very different the labor market actually is today from where it was pre-recession. In reality, the labor force participation rate and the employment-population ratio today are well below where they were before this last recession. That is, far fewer people are in the labor force and working than should be the case. For good measure, the most recent jobs numbers were nothing to get excited about, to say the least. These facts are laid out in SBE Council’s Gap Analysis #6: America’s Lost Jobs, and our analysis of the latest jobs report.

Third, and finally, speculation already has begun about whether or not the Trump economic plan will be inflationary. As stated, for example, in the MarketWatch.com story, “Some economists think the tax cuts and increased spending plans put forward by the Trump team may spark growth but boost the deficit, requiring the central bank to raise rates higher to avoid an outbreak of inflation.”

So, Let’s Look at Reality

It’s critical to get a few things straight right now.

• Number one: Economic growth does not cause inflation, nor do higher wages.

• Number two: federal budget deficits do not cause inflation.

• Number three: To the contrary, since inflation is, as the old saying goes, “too much money chasing too few goods,” increased economic growth actually works against inflation. It does not cause inflation. Inflation is a monetary phenomenon. If inflation does ignite at some point, it clearly will be a result of the Fed’s eight years of loose money finally coming home to roost. (See, for example, SBE Council’s brief analysis titled The Real Story of the Fed’s Loose Money.)

• Number four: As for the Trump agenda, to the extent that it relies on tax and regulatory relief, that will be good news for economic growth, and will be a positive in the inflation equation. But to the extent that it focuses on more government spending and/or backing away from free trade, that will work against economic growth. After all, on the spending issue, draining resources from the private sector – via more government spending (not private investment which is an option being discussed) – in order to be spent according to political preferences is never a positive for economic growth.

In the end, a Trump agenda of substantive tax and regulatory relief would wind up doing far more for the economy – in terms of both spurring economic growth and working against inflation – than will anything that the Fed seems to have in the works.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

Keating’s latest book published by SBE Council is titled Unleashing Small Business Through IP:  The Role of Intellectual Property in Driving Entrepreneurship, Innovation and Investment and it is available free on SBE Council’s website here.

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