Could higher interest rates in the US boost growth?

Economists have started to wonder if keeping interest rates low in the US is doing more harm than good.

Last week's meeting of America's Federal Open Market Committee, the interest-rate-setting group at the Federal Reserve, attracted less attention than usual due to the drama over Greece. Not that anything much happened: Fed chair Janet Yellen said the labour market had strengthened a bit, but that the Fed would need to see evidence that the recovery was gathering pace before raising rates for the first time in nine years.

In short, we got more excuses for keeping interest rates at zero when the economy is not in crisis, says Michael Lewitt on The upshot is that most are pencilling in a September hike, but they could well be disappointed. "Whatever courage the Fed demonstrated during the financial crisis has long... given way to cowardice and fear that it might upset the market by doing its job."

As the first hike approaches, the outlook for stocks has become murky. Normally, US stocks wobble in the run-up to Fed rate hikes but then keep rising, as dearer money is seen as reflecting a stronger economy. This time private and public debt is at unprecedented levels, so higher rates could slow growth much more than usual. But could higher rates actually boost growth?

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In the past few years, economists have started to wonder whether the orthodox approach by central bankers printing money to stoke inflation, thus avoiding a slump has done more harm than good. They fear that ultra-low interest rates and quantitative easing have been deflationary, not inflationary. After all, the recovery has been subpar in developed countries, and there has been scant sign of inflation taking off.

The worry is that historically low rates have kept alive many businesses that would be better off dead zombie companies and spurred investments that might not otherwise have occurred, such as the shale boom. In short, it may have depressed prices by helping to keep the overall level of supply in the economy higher than demand.

Meanwhile, savers are reluctant to spend because their cash piles don't grow with zero rates. If this is correct, it's not a great leap to suggest that higher rates could actually lift inflation and growth. So they could turn out again, after initial turbulence to be good news for stocks. We are in uncharted waters, and nobody, least of all central bankers, can be sure what happens next.

Andrew Van Sickle

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.