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Good Fed news for Christmas

Good Fed news for Christmas

Unanimous action sets Yellen ahead of G7

by Meghnad Desai in New Delhi and David Marsh in London

Thu 17 Dec 2015

The act was not swift, but, ultimately, it was decisive. It is good that Janet Yellen and the Federal Open Market Committee have done the deed. The 10 to zero majority for the 25 basis point rise in the Federal Reserve’s short-term policy rate came three months later than we had advocated (read the article here), but it is better late than never.

It may be too soon to think of the Fed chair’s legacy. Yet history will judge her as having commanded a unanimous vote for a landmark move – the Fed’s first hike since 2006 – ahead of a fraught election year in which the US central bank stands to get caught up in exceptionally rumbustious US domestic politics. Up to yesterday’s action, none of the central bank governors of the G7 leading industrial countries had any experience of tightening credit in their present jobs. Yellen now stands ahead of the men in the crowd.

Yellen is right to broadcast the hike as a signal of confidence in the US economy. We need to see the medium-run performance – the next six to eight quarters – to evaluate her judgment. It is helpful that the central bank didn't change its ‘dot plot’ for 2016 that projects one rate hike each quarter. According to this forecast, the target fed funds rate would reach 1.4% at the end of 2016.

The global economy will need to get used to the prospect of rising rates. We hope the financial markets will move away from excessive M&A valuations, share buy-backs and other signs of excessive risk-loving behaviour.

If Yellen steers well, we may escape any major financial market crisis yet. People are judging Yellen by the likely effect of the rate rise on income and employment. In this she will do well. The big imponderable is still financial stability.

The rate increase will further strengthen the Bundesbank-led, relatively rigorous faction of the European Central Bank governing council who are trying to head off unduly aggressive action under the ECB’s quantitative easing programme. Mario Draghi, the ECB president, suffered a setback on 3 December when the hawks stopped a mooted rise in monthly QE bond purchases to €80bn from €60bn. With luck, Draghi may shrug off these minor wounds and realise that this was the right outcome.

The Fed’s hike charts the beginning of a long-term adjustment of monetary policy to the twin dangers of rising inflation pressures and financial instability. Yellen and her colleagues now see that endless prevarication over the Fed’s first upward shift for nine years had itself become a factor inducing uncertainty.

Postponing the rise because of worries about Chinese growth, commodity prices or world economic disorder would have diminished faith in recovery and policy normalisation. Forging ahead is the right course. Make no mistake: the Fed move, a week before Christmas, is good news.

Meghnad Desai is emeritus professor of economics at the London School of Economics and Political Science and chairman of the OMFIF advisory board. David Marsh is managing director of OMFIF.

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