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What really matters in the Fed's rate moves


Will the Fed raise interest rates at its December monetary policy meeting? Probably. The minutes from the last meeting point strongly in that direction. Will a rate increase be bad for the economy and inhibit the rebound from the Great Recession, a recovery that's already agonizingly slow? It depends.

I believe the Fed should hold off a bit longer. Inflation isn't a problem, given it's below the central bank's own target rate of 2 percent (though some signs of rising price pressures are appearing), and labor markets haven't yet fully recovered. But a small rate hike won't do much harm. However, a large initial increase -- which I don't expect -- could.

What will higher interest rates mean to you?

In addition to the size of the hike, what's even more important, assuming a relatively small increase when the Fed does initially raise rates, is the trajectory of follow-up rate increases that people expect. The Fed will need to be very clear about its future plans. If people see this as the beginning of a series of hikes that will elevate interest rates fairly quickly, it could have a significant negative impact on the economy. However, if people expect the increases will be small and highly data-dependent, the impact will be more muted.

But communication has been difficult for the Fed recently, and its actions will speak louder than its words. For that reason, if I were in control of Fed policy, the initial increase would be small, and I would leave room to adjust in either direction. Then I'd wait until the data speaks clearly in one direction or another before changing rates again.

If not much has changed at the first meeting after the initial increase, the Fed should leave the rate where it is and continue to do so (and clearly explain why) until there's something to react to, and then react. Adjust the rate up or down by a small increment to make it absolutely clear that moves are data-dependent rather than on a steep and fixed upward march.

That does create more uncertainty than a proclamation that rates will go up by a fixed amount, e.g. o.25 percent per meeting for the next several meetings. But it would be even worse to announce such a policy and then have to deviate from it due to unforeseen developments in the economy. The uncertainty about the pace and direction of future rate increases is real, and the Fed will do best if it acknowledges that fact (as it has been trying to do), and then reacts appropriately to new economic data as it comes in.

A small increase in the Fed's target interest rate coupled with clear communication about future rate increases being highly data-dependent won't have much of an impact on the economy despite my belief that the Fed should be a bit more patient. Instead, the worry is that problems in Fed communication will cause financial markets to misjudge the central bank's intent and expect a more rapid, steeper pace of future rate increases than the Fed intends.

If that happens, the impact could be larger and harm the country's ability to finally escape from the lingering effects of the Great Recession.

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