Until this week, economists were confident the Federal Reserve would begin raising interest rates this year, either in September or December. Now, with the 11 percent drop by the S&P 500 index from its May 20 record high, all bets are off.
The concern is that the stock plunge will produce a negative wealth effect, leading consumers and businesses to feel less wealthy and thus hold back on spending.
“Prior to these market events in the last few days, I thought that this was about as close to a 50-50 call as you can get,” concerning whether the Fed will move in September, former Fed Vice Chairman Alan Blinder
told The Wall Street Journal.
“If the markets are in anything close to the sort of tizzy they have been in the last few days, then the Fed will not throw a match into the fire” at its meeting Sept. 16-17, the Princeton University economist said. He says there's a chance the Fed will hold off until next year.
Former Treasury Secretary Larry Summers is one who believes the Fed should hold off.
"A reasonable assessment of current conditions suggests that raising rates in the near future would be a serious error that would threaten all three of the Fed’s major objectives: price stability, full employment and financial stability," the Harvard professor writes in The Washington Post
Unemployment held at a seven-year low of 5.3 percent in July. And the Fed's favored inflation gauge, rose just 0.3 percent in the 12 months through June, well below the central bank's 2 percent target.
Rate hikes would hurt employment by encouraging companies to hold on to cash rather than investing in new employees, Summers says. And with financial markets in free fall, a rate rise is no longer necessary to ensure financial stability.
"At this moment of considerable fragility, the risk is that a rate increase will tip some part of the financial system into crisis with unpredictable and dangerous consequences," he states.
It appears more likely that the economy faces secular stagnation or a savings glut rather than temporary headwinds, Summers says.
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