Read more: Ben Bernanke’s reasons to be cheerful
On Wednesday, the Federal Reserve announced the first rise in US interest rates since 2006. Back then, “Thefacebook” had just been launched by a barely known student at Harvard named Mark Zuckerberg. It was that long ago. The question as to whether the Fed has done the right thing is going to linger for a while. Importantly for us here in the UK, now that the Fed has moved, does this mean the Bank of England is likely to follow sooner than expected?
Janet Yellen, the Chair of the Federal Reserve, was at pains to emphasise that the central bank would tread a very gradual policy path. The governors of the Fed expect interest rates to rise by about 1 per cent—or 100 basis points—between now and the end of 2016, but this is a hostage to events, the economy, and especially to inflation. The Fed’s view is that the economic expansion will continue at around its current pace, low unemployment could fall even further, and inflation will rise to about 2 per cent over the medium term.
It is important to see the Fed is slightly stuck between a rock and a hard place. On the one hand the circumstances against which it has decided to kick off a tightening cycle are most unusual. On the other, the circumstances under which it cut rates to zero at the end of 2008 and implemented three rounds of asset purchases under its quantitative easing programme have clearly dissipated.
Today’s unemployment rate of 5 per cent is 0.6 per cent lower than it was in 2004 when the last tightening cycle began, but other labour market measures, such as labour force participation and the number of people marginally attached to the labour force compare less favourably. Inflation today is very low, but is only slightly lower than it was in 2004, and average hourly earnings are actually rising a little faster. Against this, though, the monetary value of GDP is growing at about 3 per cent, compared with 5 per cent in 2004, and the economy is growing just above 2 per…