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Why the Fed should tighten in September

By Meghnad Desai and David Marsh
OMFIF

As the U.S. Federal Reserve approaches its moment of interest rate decision in September, an element of Hollywood bravado is creeping into the drama. Some experts from emerging market economies, especially ones such as India doing better than others because of the decline in oil prices, favor early modest U.S. credit tightening, in spite of recent stock market turbulence, as a way of building faith in a gradually recovering world economy.

Federal Reserve Chair Janet Yellen prepares to testify before the Senate Banking Committee on Capitol Hill in Washington.

One reason for such people's Clint Eastwood/Dirty Harry approach — "Go ahead, make my day" — is that subsequent resilience to an interest rate test would delineate better-performing developing nations from their peers, resulting in a relative upgrading of their credit rating. Some notable Wall Street players who have profited from cheap money are dubious about rising interest rates, even calling on the Fed to re-enact some form of quantitative easing. This has the originality of the Vatican telling us its cardinals have selected a Catholic as pope.

The Fed decision is finely balanced. No one, probably not even Fed Chair Janet Yellen herself, can be certain of the outcome. But here are 10 good reasons why she and her colleagues on the Federal Open Market Committee should opt for boldness and decide on a 25-basis-point rate rise at its next policy meeting Sept. 16-17.

1. A rate rise would chart the beginning of a long-term adjustment of monetary policy to the twin dangers of rising inflation pressures and financial instability that are likely  to ensue from past easy money policies.

2. Endless nail-biting over the Fed’s first upward move for nine years is itself a factor inducing uncertainty. Postponing the rise because of worries about world economic disorder would diminish faith in recovery and policy normalization.

3. The domestic parameters which are the main criteria governing the Fed’s policy behavior have largely moved into line with preset conditions for an interest rate increase.

4. The international environment — which the Fed takes into account in rate-setting — is not so universally negative as to preclude a rate rise. Europe is stabilizing after the Greek rescue package, and many emerging market economies benefit from low oil prices.

5. There will be winners and losers after a rate rise. Countries that have reinforced their economic fundamentals will do better than others. Financial markets should benefit from the opportunity to make a differentiated analysis of individual economies.

6. The stock market decline is an overdue correction, not a cause for panic. Allowing policy to be blown off course by market cajoling would expose Fed decision-making to more blackmail by vested interests and lower the central bank’s long-term credibility.

7. By favoring audacity over tergiversation, Yellen — long ascribed to hold dovish views — would buttress her reputation for steeliness. No G-7 central bank governor has raised interest rates in his or her present job. For Yellen to become the first one would be a mark of distinction.

8. Next year is a U.S. election year, and political resistance to a rate rise will increase. Starting the tightening in autumn would be a good way of demonstrating the Fed can withstand these challenges.

9. Fears of a further dollar rise against the renminbi (which has registered a sizable real trade-weighted revaluation over the past 12 months) and the euro are overdone. The U.S. economy is less sensitive than many others to currency overvaluation.

10. Christine Lagarde, the IMF managing director, and Lawrence Summers, the former Treasury secretary — neither supreme arbiters of good policy guidance — have advised the Fed to postpone the move. This alone constitutes a good reason for forging ahead.

 Meghnad Desai and David Marsh are advisory board chairman and managing director of OMFIF (Official Monetary and Financial Institutions Forum).  Desai is an independent non-executive director of Elara Capital.

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