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The Rate Hike: Low Rates No Answer to Slow Recovery

By Economic Indicators FOXBusiness

Seven years ago the Federal Reserve slashed interest rates to an unprecedented near-zero range hoping cheaper borrowing costs would eventually lead the economy toward a strong recovery from the worst financial crisis since the Great Depression.

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That hasn’t happened.

With the Fed all but certain to start normalizing rates next week, analysts are surveying the central bank's long foray into uncharted waters.

“In the sense that (low interest rates) prevented a true deflationary disaster it was a success,” said Cliff Waldman, senior economist for the Manufacturers Alliance for Productivity and Innovation (MAPI), a public policy and economics research organization in Arlington, Va. “What it didn’t do was stimulate the American economy back to its growth potential.”

The current recovery from the 2008 credit and housing crisis and the deep recession that followed is the weakest of any recovery since World War II, economists and analysts agree. Third-quarter GDP was recently reported at 2.1%, better than the anemic first-quarter figure (0.6%) but weaker than the second quarter (3.9%).

Tepid Growth

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The economy has grown at a tepid 2.2% average annual growth rate since the start of the recovery, compared to the 4.5% pace of previous post-World War II recoveries. In short, economic growth since the end of the recession has been a long, bumpy road apparently with no end in sight.

One of the more vexing aspects of the recovery – for economists and workers alike – has been a stubborn lack of wage growth despite otherwise solid labor numbers, notably in terms of job creation and the sharp decline in the headline unemployment rate.

“Despite near-zero percent Fed Funds Target Rate, the economy -- at least in terms of wage growth -- has been stagnant,” said Anthony Sanders, a finance professor at George Mason University.

Sanders believes weak wage growth has served as an obstacle to a more robust housing market recovery. “Mortgage demand is limited by poor wage growth and the Fed's policies have done little to improve wage growth,” he said.

Fed officials, who have been reluctant to raise rates as long as low wages have helped keep inflation well-below the Fed’s 2% target, have blamed job market ‘slack’ for the feeble growth in average hourly wages.

While all of the 8.7 million jobs lost during the 2009 recession have been recovered, many of those jobs have been replaced by part-time or temporary positions. Many of the workers filling those positions would rather be working fulltime, a situation that creates a surplus of available workers for employers seeking to fill fulltime positions. That surplus is essentially the ‘slack’ that has allowed employers to keep wages relatively low.

Waldman explained that monetary policy as set by the Fed primarily through raising or cutting interest rates has “a limited purpose.” And that purpose is to “moderate the worst excesses of the business cycle by putting a floor under the worst downturn and a ceiling on inflationary surges,” he said.

Taken Their Toll

Fiscal policy – regulation, tax reform, job training, etc… -- has a much greater impact on the long-term economic picture, according to Waldman, and that policy is set by Congress, which has essentially been stuck in a stalemate for years.

In any case, low interest rates have taken their toll on an array of demographics and industries. They include savers, specifically retirees who live on fixed incomes, many of which such as CDs and municipal bonds are closely tied to interest rates. While rates have been rock bottom so have the returns on these folks’ savings accounts and investments.

“It really hurt savers, retirees in particular, because interest income was decimated for years,” said Bankrate.com’s chief financial analyst Greg McBride.

Countering the point that low interest rates helped boost stock prices and thus contributed to an expansion of American household wealth, it should be noted that most American families -- 52% -- don’t own any stock either directly or through a mutual fund or retirement account, according to a recent Bankrate.com survey.

Banks have also suffered to some degree under low interest rates. For seven years low interest rates have squeezed banks’ net interest margins, or the difference between what banks pay depositors on their savings accounts and the rates the banks earn from borrowers. That margin will rise once interest rates rise.

The U.S. manufacturing sector has also been punished by low global interest rates as foreign investment in the U.S. dollar has inflated the value of the American currency, making U.S. exports more expensive.

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