CSUF News Service

Economist Discusses Expected Federal Reserve Interest Hike

Mira Farka

Economist Mira Farka believes the Federal Reserve will increase interest rates tomorrow.

All eyes are on the Federal Reserve this week as the Federal Open Market Committee (FOMC) — the body responsible for setting interest rates — meets for the last time this year.

"This is a momentous event: most market participants expect the Fed to raise interest rates for the first time in eight years," says Mira Farka, Cal State Fullerton professor of economics and co-director of the Woods Center for Economic Analysis and Forecasting. "Interest rates have remained at the zero-bound (at or near zero) since December 2008. The last rate-hiking cycle began in 2004 — more than eleven years ago."

Farka, who previously worked as a senior economist for Deutsche Bank in New York, says that the Fed has been on hold, making sure the economic rebound has taken hold before proceeding with interest rate hikes.

"In fact, the FOMC has been casting about for the last two years for any excuse to stay put on rates,” she says, adding that such delay “has inflicted real costs in the world economy. More than $1 trillion has fled the emerging markets in search for higher yields elsewhere.”

Farka believes the feds should have increased interest rates “at least one year ago. Normally, an interest rate increase has a contractionary effect in the economy as it raises the costs for business and customers alike. This time, a decision to finally commence the rate-hiking cycle would be largely a net plus — not in the least because it will remove much uncertainty from the market."  

The arguments in favor of raising rates, Farka says, are quite strong.

"First, the labor market has improved appreciably compared to the depth of the recession. Labor market slack is now much smaller: those who have left the labor market — the long-term unemployed, the discouraged and the marginally attached — are unlikely to rejoin the labor market in droves. Wage inflation may not be imminent, but this is more of a reflection of low productivity than unresolved labor market slack.

"Second, the output gap appears to be smaller: low productivity and slow growth in the labor force may have dented the economy's potential, at least in the near term.

"Third, current low-inflation rates are a reflection of a plunge in oil prices, imported deflationary pressures from abroad and a sharp broad-based rise in the dollar.”

She expects inflation to remain well contained over the next couple of years and reach the Fed’s target rate of two percent by 2018. “Given the lags with which monetary policy tends to affect the real economy, the Fed needs to tighten now in order to head off the buildup in potential inflationary pressures.”

So Wednesday, Farka expects the FOMC to increase the interest rate. “I also see a path to normalization that will be persistent and very gradual, with interest rates topping off at around the 3-3.25 percent range."

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