“Unknown unknowns” and the Fed’s failure to confront reality

Will they? Won’t they? Should they? Shouldn’t they?

Every business analyst has been pondering whether the US Fed’s Open Market Committee would raise interest rates this week. Now we know with one exception there was a collective failure of nerve and interest rates have been held at their current level.

In essence the first rates rise since 2008 would have signalled the start of a return to normality and an indication that we are coming out of recession, which in our view would have been welcome. But clearly they bottled it.

The BBC’s Robert Peston opined that there was never a risk free time to raise interest rates. Indeed there is no comparison in history from which to infer the possible consequences.  This is because there has never previously been such a long period of near-zero rates.

This view was shared by business writer Hamish McRae, writing in the London Evening Standard on Monday.

We know some of the drawbacks of low interest rates.  Savers suffer because their savings earn them little or nothing. Borrowers, particularly household borrowers with mortgages, gain because they pay less interest although all too few have used this as an opportunity to pay down debt.

The fact is that those with a large debt, be they an individual, a business or a national economy, would face increased costs in paying back the debt following a rate rise and that would impact on future plans.

Plainly the worry about the destabilising effects of a rate rise on emerging economies (particularly Russia, Brazil and China) and the potential pain from rising prices and increased repayment costs for those that are have borrowed heavily to finance their economic growth played its part in the Fed’s decision.

But perhaps most of all the question of timing that has been exercising people and the “unknown unknown” of what a rate rise would do to a less than stable, post-2008 global economy was what justified the Fed for “wimping out” by kicking the can down the road.

Another “unknown unknown” may have contributed to their failure to confront reality, that of being held responsible for the unknown consequences.

We do, however, know that cheap money has distorted the markets and may have stored up potential for a crash. Such financial bubbles can only grow while interest rates remain low and the reality is that if a bubble is growing then the next crash will be bigger the longer it is put off.

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