Road to recovery may be paved with higher interest rates, suggests Treasury Secretary Janet Yellen
Advocating for President Joe Biden’s ambitious $ 4 trillion spending proposals, Treasury Secretary Janet Yellen said policymakers should learn to familiarize themselves with the idea of moderate inflation, even if it means higher rates.
“If we ended up with a slightly higher interest rate environment, it would actually be a plus for the company’s point of view and the Fed’s point of view,” Yellen said in a statement. Bloomberg News interview Sunday. “We have been fighting for a decade against too low inflation and too low interest rates.
Arguing that the fear of fluctuating interest rates is overblown, Yellen asserts Federal Reserve Chairman Jerome Powell’s position that price hikes are transient and – so far, at least – remain within the policy objective of the central bank.
“Higher interest rates by themselves are not necessarily good for consumers. But if it’s the result of successful fiscal policy implementation, Yellen and other Democrats argue it’s perfectly correct, ”said Ben Koltun, research director at Beacon Policy Advisors.
But economists have raised concerns, with some suggesting that growth models healthy enough to support a reasonable amount of inflation are overly optimistic.
“If the economy were really booming, rates would naturally rise, but they weren’t,” said Joseph LaVorgna, managing director and chief economist of the Americas at Natixis. “To get higher rates, you have to have a strong economy. “
The impact of the pandemic on consumer behavior has skewed spending on durable goods by pushing it forward, LaVorgna said. He predicted that even an increase in the consumption of services over the next few quarters might not be enough to close this gap, as an unspecified amount of service sector spending could remain depressed if Americans remain reluctant to engage in any. activities with high levels of people-to-people contact.
Higher interest rates could spill over into the housing market – which is already facing higher prices due to supply constraints – and drive up borrowing costs across the board. Ted Rossman, senior industry analyst for CreditCards.com, said that even with the Fed’s benchmark interest rate close to zero, credit card customers haven’t really benefited.
“As much as we’ve been talking about a record interest rate environment, it hasn’t spread to credit cards,” he said, adding that the average APR for new card accounts is just over 16%. If the Fed were to raise interest rates sharply to contain inflation, borrowers could also see the cost of servicing their revolving debt rise.
LaVorgna speculated that Senate rules limiting spending Congress Democrats could push through without bipartisan support could ultimately lead to negotiations that dramatically reduce the size and scope of Biden’s economic agenda.
“This suggests to me that whatever bill passes, it will be… smaller. This will support the rate cut for two reasons, ”he said, as Wall Street’s expectations will be tempered and the Fed will be inclined to continue its accommodative monetary policy.
Such a degree of uncertainty has prompted policymakers to reassess their assumptions about the best methods to support the recovery.
“There has been a paradigm shift in the fiscal versus monetary policy debate in Democratic politics over how best to stimulate the economy,” Koltun said. In the past, “monetary policy was seen as the main force for economic growth”, but today “there are limits in a low rate world to what monetary policy can do,” he said. he declares.
The main limitation of monetary policy is that the Federal Reserve has the power to lend but not to spend, as the saying goes, which prompted the Biden administration and most Democratic lawmakers to embrace an unprecedented experiment of stimulating fiscal policy.
“Yellen is arguing for strong fiscal policy with the US Jobs Plan and the US Family Plan, as well as the US $ 1.9 trillion bailout,” Koltun said.
Yellen recently sought to reframe that total of $ 6 trillion in proposed spending, telling Bloomberg: “They are not meant to stimulate, they are meant to invest to meet the longstanding needs of our economy.”
Former Treasury Secretary and Director of the National Economic Council, Larry Summers, has been one of the most prominent figures in the Democratic establishment warning of the potential risk of soaring inflation. Summers called overheating the “main risk to the US economy” in a Washington Post Opinion Column last month titled “Inflation Risk is Real”.
“While continued relief efforts are essential, the focus of our macroeconomic policy must change,” he wrote, highlighting recent increases in consumer prices and inflation expectations. “The story here is not encouraging. Anytime the Fed braked hard enough to slow growth significantly, the economy went into recession. “
Yellen, the former chairman of the Federal Reserve herself, expressed confidence that Powell’s Fed can avoid that fate – a show of faith that could ultimately define her legacy as head of the Treasury Department. “It’s always a game of expectations,” Koltun said. “This is something that can be very difficult for the Federal Reserve to control.”