Rising Interest Rates
April 19, 2004
The Federal Reserve has had a highly accommodating monetary policy for more than three years. Some analysts argue the Fed's easy money policy has been channeled mainly into housing prices up until now. One hears more and more talk about a bubble in the housing market like the one we saw in the stock market in the late 1990s, says Bruce Bartlett.
Public statements by various Fed officials show that many are still concerned about deflation. Also, some Fed officials are convinced that inflation can only result when unemployment falls well below where it is today. However, all Fed officials recognize that the time will come when it must begin to tighten monetary policy.
But money is fungible and eventually spreads throughout the economy, explains Bartlett:
- In the early stages of inflation, it raises corporate profits because businesses can raise their prices faster than their costs rise, especially for labor.
- Thus it is not contradictory for the stock market to rise even as interest rates rise -- if the basic cause is an inflationary monetary policy.
- Furthermore, investment may not be impaired because companies will be able to raise capital in a rising stock market, rather than borrowing in the bond market.
Although the Fed's easy money policy and rising inflationary expectations are the primary cause of rising rates, says Bartlett, there those who say that the federal budget deficit is the main culprit and that higher taxes are needed to bring down interest rates. They would do well to remember that rates rose sharply after Bill Clinton's tax increase in 1993. In 1994 alone, a year when the budget deficit fell sharply, rates rose by 2 full percentage points.
As in medicine, a proper diagnosis for the economy is essential before implementing a cure, says Bartlett.
Source: Bruce Bartlett, "Rising Interest Rates," National Center for Policy Analysis, April 19, 2004.
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