The Fed makes its move; what's ahead in 2016?
Well, the Fed went and finally did it. For the first time since June 29, 2006 - 9½ years ago - the monetary authorities increased interest rates.
Well, the Fed went and finally did it. For the first time since June 29, 2006 - 9½ years ago - the monetary authorities increased interest rates.
But the first move by the Fed is not that critical. What we need to know is how fast interest rates will rise going forward and what that might mean for the economy in 2016. My expectation is that rates will increase gradually, at least until the fall, allowing the economy to grow faster next year than it did this year.
OK, why in the world would the Fed want to increase interest rates? It is not as if the economy is booming and inflation is a real threat.
True, but the Fed has to be forward-looking. Monetary policy works with a lag, and it makes sense to start raising rates before issues arise.
We must also remember that the historically low, near-zero rate was a crisis rate, not a normal one, and the crisis is over. In a typical economy, the funds rate, which is what the Fed controls, should be around 3.5 percent.
Clearly, the Fed has a lot of work to do and many rate hikes before it can say "all's well." And since the members don't want to increase rates too quickly, the sooner the process begins, the more cautiously the Fed can move.
But there are other factors driving the Fed. The low rates are warping perceptions. Businesses and households are starting to view current rate levels as normal and are factoring them into their long-term decision-making.
The longer rates remain artificially low, the more resources are misallocated. That raises the risk of an overreaction to the inevitable rise in rates.
Another, and maybe even more important, concern is that after 6½ years, the expansion is getting a little old. The longest expansion on record lasted 10 years, so we could easily grow for another few years. But if the economy goes into recession before the Fed has moved rates up to normal levels, its major tool of fighting a recession - lowering rates - would be limited. For all these reasons, the Fed's action was reasonable and necessary.
With interest rates likely rising slowly but steadily, can the economy grow solidly next year? Absolutely. The key will be wages.
Yes, I know, waiting for wage increases has been no different from waiting for Godot, but he just might finally show up. With the jobless rate essentially at full employment, further declines should create labor shortages in most regions and across industries and occupations.
Whenever labor shortages have appeared in the past, wage increases followed. There is no reason to believe that the laws of economics have been repealed this time.
Business leaders may think they can hold the line, but eventually they will have to decide between paying people more to take all those jobs they cannot fill and losing business. The choice is really simple: You pay more.
Once worker incomes start rising more solidly, the economic forecast follows directly: Consumers spend more, businesses produce more, hiring and wages increase, and growth accelerates.
The housing market should heat up as rising mortgage rates force dawdling home buyers to get off the fence and make offers.
And with consumer demand increasing, businesses will feel confident enough to invest more. We may even see oil prices rise, though I don't think a lot of people outside the energy sector are rooting for that.
So, here is my 2016 fearless national economic forecast: We are set up for solid growth.
The economy, which in 2015 expanded by about 2.5 percent, should improve to about 3 percent. The unemployment rate could drop to or even below 4.5 percent by year's end. And interest rates will rise at least one percentage point.
That is a forecast we can all live with, as it is not too hot, nor too cold. I am not saying I believe in fairy tales, but it really could be a Goldilocks economy.