Fed Should Keep Rate at Zero Until Mid-2016 to Avoid 'Dark Corners,' IMF Paper Says

        By Pedro Nicolaci da Costa
        The Federal Reserve should wait until the middle of 2016 to start raising short-term interest rates from near zero to ensure the economy is on a firmer footing and inflation is returning to the central bank's 2% target after undershooting it for more than three years.
        That's the message from a new working paper from the International Monetary Fund that lends some technical chops to the argument the fund's Managing Director Christine Lagarde has been making to both U.S. and European officials: The world economy is still fragile and inflation very low, so don't rush to tighten monetary policy just yet.
        "Such a risk management approach to monetary policy would result in both a later liftoff of policy rates and a modest, but planned, overshooting of inflation," says the paper by a group of eight authors.
        The charts below show the divergent predicted paths of various economic indicators under the IMF's proposed approach versus the Fed's existing "flexible inflation targeting" system:
        Fed officials have said they expect to raise their benchmark short-term rate this year if the economy strengthens.
        Many of them started 2015 talking about a possible midyear rate increase. But they dropped that idea after the economy contracted in the first quarter and some have spoken recently about making their first move in September or December.
        The IMF approach would encourage officials to wait even longer, perhaps until mid-2016. That's because of the argument, made by some top Fed officials, that the risks of moving rates higher too soon outweigh the costs of keeping them low for too long. The Fed has kept the benchmark federal funds rate in a zero to 0.25% range since December 2008.
        If the Fed raises rates too soon, this thinking goes, it could cause the economy to stumble again. And since rates would still be very low, the central bank would have a limited ability to cut borrowing costs to spur growth. In contrast, if the Fed waits too long to move and sparks too much inflation, it can simply raise interest rates to cool price increases.
        Two Fed officials, Chicago Fed President Charles Evans and Minneapolis Fed President Narayana Kocherlakota, have said they think the central bank should wait until next year to raise rates.
        Related reading:
        Fed Flags Slow Pace of Rate Hikes
        Fed's Evans Continues to Advocate for Early-2016 Rate Increase
        Fed's Brainard Wants More Economic Progress Before Rate Rises
        (END) Dow Jones Newswires

        June 29, 2015 06:32 ET (10:32 GMT)

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