It
hasn’t been an easy task for academics and practitioners to fully unravel the
dynamics of financial globalization which has evolved beyond the predictable
structure that was in place back in the 50s. The world as we live in now has
developed peculiar issues that need new ideas although historical knowledge are
still valuable in some context.
The role of the
Federal Reserve has transformed over time from its main task of controlling
short-term rate of interest in order to achieve long-run inflation target and
the last time the benchmark interest rate was raised in June 2006, there was
not as much media noise. The market has been anticipating a raise in the
benchmark interest rate this year and all focus will be on the next
rate-setting Open Market Committee meeting of September 16th – 17th.
The Fed as a lender of last resort is liable to intervene with a rate increase but
lend freely as was the case during the first stages of the 2008 crisis to supposedly
manage the balance between elasticity and discipline. Although the American
economy seem to be at its finest over the years with 2.3% annual rate in the
second quarter of 2015, there are still concerns of
economic recovery.
Unemployment
figures fell to 5.1% in August as firms continue to create jobs - the lowest
unemployment rate since April 2008 as the number of unemployed persons fell to
8 million - a buffer for the Fed to gradually raise its rate without hurting
the economy. The inflation figure for July stood at 0.2%, many basis points shy
of the 2% inflation target - a trend that has been on for more than 3 years. The
need for the Fed to act in haste can also be adduced to the certainty that soon
enough yield-hungry investors will take some huge risk due to low cost of
borrowing thereby laying the foundations for a financial crisis.
The
global economy is weakening yet the Fed is pushing to tighten. The USD has
increased by more than 19% on a trade-weighted basis in the past year pushing
aggregate income to a level that supports a change in rate of interest. This is
such that an attempt to keep money rate below the rule level for a longer
period could fuel another bubble already perceived to begin in China.
The concern for the
emerging market community is one of capital flows now that commodity prices are
hitting record lows and the reflection of global prices on rate of interest which
should be a function of price of time rather than price of liquidity. If the
rate hike comes at a premature time, it could be more devastating and could lead
to deflation in no time. This might result in another round of quantitative easing
by the Fed and distortions in other markets.
The outcome of the September meeting is key
to many decision makers but a no-hike will be celebrated in the meantime.
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