Is now the right time for a Fed rate increase from record lows? Here are 2 clashing views

For seven years — through political fights, Europe debt crises and market panic — investors could count on one thing: Short-term U.S. interest rates would stay locked near zero.

Such was the will of the Federal Reserve, which remained wary of the economy's durability long after the gravest recession since the 1930s had ended.

Now, with a vastly strengthened economy, the Fed is weighing whether to start phasing out the era of easy money on Thursday. It would be its first rate hike since 2006. Awaiting the decision, markets have been gripped by tension.

Ask some economists, and they'll tell you now is the time for a hike. Not so soon, others say.

Here's the case for a rate hike now — and the case for delaying it — as summarized by two AP reporters.




What's the Fed waiting for?

The economy keeps expanding, and employers keep hiring: They've added . 12.6 million jobs since 2010 — far beyond the 8.7 million lost to the Great Recession. The unemployment rate is 5.1 percent. It hasn't been that low in seven years. Cars are flying off lots at the fastest pace since 2001.

Home purchases have regained their pre-recession levels. Americans are flocking to trendy new eateries, lifting restaurant and bar sales a healthy 9 percent in the past year.

"And here we are worrying about whether the economy could possibly withstand a quarter-point hike," says Paul Ashworth, an economist at Capital Economics, a forecasting firm.

Critics argue that by continuing to pin the rate it controls at a record low long after the economic crisis has faded, the Fed remains oddly in a state of emergency. In 2008, when it first slashed its rate to near zero, the financial system was teetering. The economy was hemorrhaging jobs. Unemployment would soon hit 10 percent. Big banks and car companies needed bailouts.

Since those dark days, individuals and companies have repaired their finances. They may no longer need ultra-low rates to borrow and spend.

It's true that pay raises are still meager. And a lot of Americans have given up even looking for work — a trend that has artificially helped shrink the unemployment rate. But otherwise, many analysts note, today's economy is just the kind that the Fed would presumably want: Steady, sustainable growth that doesn't seem to have inflated bubbles in stocks or housing.

So far. That might change if rates stay at zero much longer.

Joseph Carson, U.S. economist at AllianceBernstein, points out that higher stock and home prices have boosted Americans' wealth to a level equal to six times income. That's akin to levels reached at the peak of bubbles in stock prices (1999) and the housing market (2007).

The bursting of those two bubbles triggered recessions. Modest rate hikes starting now could help avert another such disaster and actually prolong growth, Carson says.

Some economists don't want the Fed to hike until paychecks start accelerating. Average hourly pay has risen just 2.2 percent in the past 12 months, below the 3.5 percent rate considered healthy.

But sluggish pay increases may partly reflect lousy growth in worker productivity in the past five years. And there's probably little the Fed could do about how efficient workers are anyway.

What about the stock market turbulence? Some analysts have pointed to that as a reason to delay a rate increase. Yet the market's woes may be due in part to uncertainty around the Fed's timetable for a hike. A rate increase would end the uncertainty. It might also reassure investors that the Fed is confident in the economy.

Inflation does remain below the Fed's 2 percent target, having risen just 0.3 percent in the past 12 months, according to the central bank's preferred gauge. But advocates for a rate hike say that mostly reflects the plunge in energy prices in the second half of last year. Jeffery Lacker, president of the Federal Reserve Bank of Richmond, notes that since January, overall prices have risen at a 2.2 percent annual rate.

Some economists who want the Fed to postpone a rate increase think a delay would allow the economy and pay growth to strengthen further. But a scant hike in the Fed's short term rate wouldn't likely weigh on growth. The Fed wouldn't be trying to rein in an overheating economy. It just wants to slowly withdraw the emergency aid it's supplied for seven years.

"It's not like there will be no stimulus," Ashworth says. "There will be just slightly less stimulus than there was before."




Why put the economy at unnecessary risk?

That's the fundamental argument against a Fed rate hike now: In light of fear about China's weakening economy and anxiety in financial markets, some analysts argue, why not play it safe until the picture brightens?

The usual factors that compel a rate hike — signs of an overheated economy building inflation pressures, for example — are nowhere to be found. Not yet, anyway. Keeping the Fed's benchmark at record lows might further support borrowing, spending and growth.

That's why Christine Lagarde, managing director of the International Monetary Fund, has implored the Fed to wait.

"The economy would be better off with a rate hike in early 2016," Lagarde said in June.

Lagarde and like-minded Fed watchers worry about the risk that a rate hike would prove premature — and end up damaging the economy. They feel that that risk outweighs the possibility that the Fed might wait too long to raise rates and cause inflation to rise too fast.

Consider what happened when an impatient European Central Bank hiked rates in 2011, two years after a devastating downturn. The countries that share the euro currency tumbled back into recession. The ECB has since reversed course and begun pumping money into the European economy to try to revive growth.

Might the Fed risk the same mistake?

Nor is the inflation bogeyman in sight. The Fed's favored measure of price levels rose a barely visible 0.3 percent in July from a year earlier — or 1.2 percent, if you exclude volatile food and energy prices. That's well below the Fed's 2 percent target.

"We simply don't have inflation," says Sung Won Sohn, an economist at California State University Channel Islands. "There's little prospect it's going to approach 2 percent anytime soon."

A Fed rate is hike is supposed slow an overheating economy. Though the U.S. economy is fairly healthy, it's hardly booming.

American employers have added an average 212,000 jobs a month so far this year — solid but down from last year's average of nearly 260,000. The unemployment rate has reached a seven-year low of 5.1 percent, but that's partly because an unusually large proportion of Americans have stopped looking for work and are no longer counted among the jobless. Hourly pay growth remains meager.

Troubles abroad give the Fed even more reason for caution, say opponents of a rate hike.

The Chinese economy has been slowing at a worrisome rate. Even though China's official reports still show enviable growth — 7 percent from April through June from a year earlier — its economic statistics are widely regarded as inflated. Many China watchers fear that actual economic growth is far worse.

Skepticism intensified after Chinese authorities caught the world by surprise last month by devaluing their yuan currency. Beijing insisted the move was just meant to catch up to market signals that the yuan was overvalued. But the move also seemed to suggest desperation — a bid to give Chinese exporters a price edge and juice an economy that must be worse than anyone realizes.

China's diminished appetite for foreign commodities has hurt developing economies — from Brazil to Nigeria — that depend on Chinese demand for raw materials. The IMF has warned that China's slowdown appears to be causing damage beyond its borders.

Which doesn't exactly brighten the outlook for the U.S. economy. If our economy is really so healthy, why aren't wages rising significantly? And if the U.S. economy is still less than robust, is there any compelling reason for the Fed to hike now?

"Are we at full employment?" Harvard University economist Kenneth Rogoff says. "We don't know. We've gone through a storm, and we don't quite know where the ship is."


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