Should the wingpsan of a hawk equal the wingspan of a dove?

Janet Yellen is in a tough spot.

The US Federal Reserve chair presides over a country in pretty good economic health. Unemployment is just 5.3 per cent. But the official interest rate is zero (technically 0 to 0.25 per cent), and there is huge pressure to not raise that official interest rate.

This is odd. Many say she should hike rates. But there is plenty of precedent for being very cautious about raising rates.

Both Australia and New Zealand lifted interest rates from their GFC lows. Australia did so in 2009, NZ twice in 2011 and 2014. Both countries dropped rates again soon afterwards, as these graphs show, .

Screen Shot 2015-10-17 at 12.07.33 pm Being hasty in raising rates is unwise.  Yellen’s cautious stance is probably appropriate.

Her position is especially difficult because her options are so limited. US rate changes, by convention, happen in lumps of 0.25 percentage points. Just like Australia’s and New Zealand’s.

She faces, by convention a binary choice. Leave rates steady, or execute a 0.25 point hike that could frighten markets.

A quarter of a percentage point probably appeared vanishingly small back in those dimly remembers normal times, when interest rates were so much higher. The size of a standard rate move now raises questions.

The key one: Should rate rises be the same size as rate cuts?

Economies tank hard.  Recoveries are slower and more tentative. Unemployment rises steeply and falls slowly.

Recessions send unemployment spiking. And so can low growth.

There is an implicit understanding that rate cuts can be bigger than hikes. The Australian government bundles groups of 0.25 together when things go bad particularly quickly. For example the RBA made a cut of 0.50 in 2012, and three cuts of 1.0 in late 2008 and early 2009.

But there is no explicit understanding that rate cuts could be smaller than 0.25 when they are rising.

Why? There is no apparent technical impediment to this.

Australia is now perfectly capable at holding rates at levels more tightly defined than 0.25 per cent intervals, as this graph of the target (red) and actual (black) rate shows:

Screen Shot 2015-10-17 at 12.27.37 pm

Whether Yellen should raise rates is a divisive issue. She should counter that political division with a bit of  arithmetic division.

Splitting her first hike into several small pieces is the answer.  Rises of 0.1 per cent – or even smaller – could be just the trick at difficult times like this.

4 thoughts on “Should the wingpsan of a hawk equal the wingspan of a dove?”

  1. Re Bunnings Vs Masters
    Loved the article. but spare a thought for the struggling family businesses getting smashed by both these groups and price squeezed by suppliers who are trying to top up dropping margins as they get squeezed by Coles and Woolworths

    How the hell can these Business survive ? don’t worry about masters if all these small businesses die you will have a duopoly that will agree on set prices and we will all pay more
    Support small business

  2. RE Rate rises – makes total sense. Sticking to increments like .25 off such a low base just because of convention is crazy.

  3. Re: rate rises
    I do agree with your assessment that there is the potential for less than a 25 point increase in interest rates, however I would suggest that any kind of interest rate rise at this point in the US would be less about controlling inflation and more to do with stimulating investor confidence. If there is a lower than normal rate rise, perhaps the actions would have less of an impact on the precautionary demand for money.

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