Fed may shun ‘gradualist’ rate hike pace

Fed may shun ‘gradualist’ rate hike pace
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First Published: Sun, Sep 13 2009. 09 42 PM IST
Updated: Sun, Sep 13 2009. 09 42 PM IST
New York: The last time the US Federal Reserve was raising interest rates, it did so at a snail’s pace. But it may not take that gradual approach to tightening policy the next time around.
Fed officials are stressing there will be no exit from the US central bank’s extraordinarily accommodative interest-rate stance for an “extended period” and analysts do not expect the first rate hike until 2010 or 2011.
The US central bank slashed its benchmark overnight borrowing costs close to zero last December as part of an emergency rescue of the US economy that included a raft of extraordinary lending and purchase programmes, such as buying mortgage-related debt.
Fed watchers say it would be able to keep its low-rate pledge more easily if it were perceived as ready to move up quickly when it finally does begin to tighten. In its last rate-raising cycle from mid-2004 to mid-2006, the Fed raised the overnight federal funds rate by a slim quarter point at each of 17 consecutive meetings.
This deliberate policy, known as “gradualism”, aimed to be predictable so as not to disrupt markets. In a 2004 speech, then-Fed governor Ben Bernanke had discussed reasons for gradualism, as well as an alternative, which he called the “cold turkey” approach. Many economists believe the decision to raise rates at a “measured” pace after a long period, in which they were unusually low, kept monetary policy too easy for too long, fuelling the housing bubble that led to the current crisis.
Federal Reserve Bank of Chicago president Charles Evans said last week that the pace of tightening was “perhaps a little too measured”. The Fed would want be more aggressive next time, he said. “We are probably in a period where gradualism is less important than getting to the right stance in policy,” Evans said.
To be sure, the first hike won’t mean policy has suddenly become restrictive. With rates currently near zero, it would simply start taking them to a more normal base.
Indeed, the Fed may not turn aggressive until it is clear the economy needs more restraint. Interest rate futures markets, however, are pricing in a relatively gradual approach to rate hikes. While the first increase fully priced in is a relatively large half-point move in June 2010, the market sees rates up to only about 1.25% by the end of the year.
Of course, any decision to raise rates will depend greatly on how the economic recovery plays out.
Fed officials have warned that the recovery will be slow and tentative. Of course, raising interest rates is not the only way the Fed could begin to withdraw its economic supports. Reversing some of its unorthodox lending and purchasing measures would be another way for the central bank to start moving policy back toward a more neutral stance.
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First Published: Sun, Sep 13 2009. 09 42 PM IST