Central Banks: Are they right to raise interest rates if there is no inflation? - Natixis

Despite the rapid decline in unemployment in the United States and the euro zone, there has been no acceleration in labour costs that could drive up core inflation, points out Patrick Artus, Research Analyst at Natixis.

Key Quotes

“The Federal Reserve is going to continue to raise its interest rates, while the latest statements from the ECB suggest that it will wait for inflation to return to the vicinity of its 2% inflation target before doing so.”

“This begs an important question: is a central bank right to raise its interest rates when the unemployment rate is low and there is no inflation?”

“We think the answer is yes, as:

• The absence of an increase in interest rates eliminates any chance of monetary policy responding to a downturn in activity, which is always possible late in an expansion period;
• The absence of an increase in interest rates lets financial imbalances develop: overborrowing, asset-price bubbles. We do not believe that macroprudential policies are a substitute for monetary policy when it comes to preventing financial imbalances;
• There is no sign that the “overheating” theory is valid: productivity gains are not accelerating despite monetary policy remaining expansionary.”

“So we think that the Federal Reserve’s approach to the absence of inflation while the unemployment rate is low is preferable to that of the ECB.”