Remember Isaac Newton’s laws of motion? You know the one: A body in motion will tend to stay in motion unless there’s an external force.
Without the data that would be needed to make a smart decision, the Federal Reserve has opened up the possibility of raising interest rates sometime this year—and as early as this week. Having started down that path, there will be pressure to keep on that path even if it doesn’t make sense. Matt O’Brien at the Washington Post put it this way recently: “some people are tired of this debate. The Fed hinted it might raise rates now, and, by golly, that’s what they want it to do, whether or not the data actually support that … [however, those] are psychological arguments, not economic ones.”
If the Fed raises rates, there’s another law of motion that will come into play: For every action there is an equal and opposite reaction. A Fed rate hike could be a real downer for the economy. Here are four reasons you should care if the Fed goes ahead and does it.
1. Slowed economic growth and lower prospects for wage gains.
“The Fed’s plan to slow the economy [by raising interest rates] will not only affect jobs, it will also reduce the ability of workers to secure wage gains … the Fed can’t always boost the economy as much as it might like with lower interest rates, but it certainly can slow the economy by raising interest rates high enough,” economist Dean Baker, co-founder and co-director at the Center for Economic Policy and Research (CEPR), wrote earlier this month.
In this economy, we’ve seen highly qualified college grads, even those with STEM degrees, take low-paying jobs that don’t require the education they have obtained, he told me. With the weaknesses in the global economy and no inflation, we do not need slower growth, he says. Even a quarter-point increase in interest rates right now “would be a step in the wrong direction,” he told me.
2. Demand for workers is already sluggish and could weaken further.
“The main problem in the labor market is a broad-based lack of demand for workers,” Elise Gould, senior economist and director of health policy research at the Economic Policy Institute (EPI) wrote on Sept. 9 in response to the latest jobs data. “There continues to be a significant gap between the number of people looking for jobs and the number of job openings … on top of the 8+ million unemployed workers warming the bench, there are still more than three million workers sitting in the stands with little hope to even get in the game.”
A Fed interest rate increase would be ”very premature and bad for the economy,” Josh Bivens, research and policy director at EPI, told me. “And “with current trends, December would definitely be too soon,” he says. “There’s a lot of slack in the labor market,” Bivens told me. (The Fed’s most recent worker survey showed 36% of workers would like to work more hours for more money, and the underlying data hasn’t changed significantly since then.) Plus there’s been “super weak performance of wages,” he says. “And if wages aren’t going up, we aren’t going to spark inflation any time soon.”
3. Even now, projections for future job and wage growth aren’t as rosy as they were just a few quarters ago.
According to the Duke CFO Global Business survey released on Sept. 10, U.S. CFOs now expect to cut jobs for temporary workers in the next 12 months, while growth in full-time jobs and outsourced employment is expected to significantly slow, compared with similar forecasts in previous quarters this year. Employment forecasts do appear to be “weaker,” Duke University finance professor and study author John Graham, told me. And while CFOs expect wages will increase over the next 12 months, their view on the size of increases is unchanged from last quarter and lower than they were projecting at the end of 2014.
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4. The results of an interest rate increase could be catastrophic—or at least much worse than we may be able to predict.
“I believe that conventional wisdom substantially underestimates the risks in the current moment. Most [recessions] were not recognized till long after they started, economist and former Treasury Secretary Larry Summers wrote on Sept 9. “And if history teaches anything it is that financial interconnections are pervasive and not apparent till it’s too late…If the Fed tips towards tightening, it risks catastrophic error. Now is the time for the Fed to do what is often hardest for policymakers. Stand still.”
The risk is also that having started a rate rise, the Fed won’t be able to stop itself. “If as some suggest a 25 [basis point] increase won’t affect the economy much at all, what is the case for an increase?” Summers wrote. “And when the same people argue that 25 BP will have little impact and that it is vital to get off the zero rate floor, my head spins a bit.”
The best we can probably do at this point is to jump from Newtonian to quantum physics and apply the law of observation. Perhaps by keeping our eye on the Fed, we will be able to change the shape of its decision.
Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://www.thevaluealliance.com), an independent board education and advisory firm she founded in 1999. She has been a regular contributor to Coins2Day since April 2010 and is the author of two books on corporate governance and valuation.
