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Tai Hui
Tai Hui

Opinion | Why the Federal Reserve is taking a modest approach to raising interest rates

  • The Fed’s more aggressive policy-tightening stance is not surprising in the face of US inflation
  • However, the expected interest rate rises two or three times a year seem relatively restrained given that unemployment is not a huge concern

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Clouds gather over the US Capitol in Washington on December 10 when the Senate passed legislation creating a fast track to raising the nation’s debt ceiling. The US government’s rising fiscal debt is a factor that could constrain the Fed’s ability to raise interest rates. Photo: Bloomberg
Tai Hui
The US Federal Reserve is ending 2021 with a bang, accelerating its policy normalisation and predicting raising interest rates earlier than previously anticipated. While inflation is an immediate concern, there are constraints on how aggressive the Fed could be in raising interest rates in the long run.
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In its latest monetary policy setting meeting, the Fed said it will reduce asset purchases by US$30 billion each month, instead of by US$15 billion as announced in November. This implies its quantitative easing programme will end in March instead of June.

It is also forecasting three policy rate hikes in 2022 instead of just the one in its September forecast. The first rise could come as early as June.

Given that US inflation has hit a multi-decade high, the Fed’s more aggressive policy-tightening stance is not surprising. However, its projection for policy rate increases in 2023 and 2024 is still modest. Even with the unemployment rate forecast to fall below the long-term projection of 4 per cent, the Fed only expects to raise the policy rate two to three times a year. Why?

A man walks past a “Help Wanted” sign in New York on June 4. The US unemployment rate fell to 4.2 per cent in November. Photo: Getty Images/AFP
A man walks past a “Help Wanted” sign in New York on June 4. The US unemployment rate fell to 4.2 per cent in November. Photo: Getty Images/AFP
One explanation is that inflation will decline as the world normalises. Supply chain disruptions should be resolved in the next six to 12 months. Energy prices should also stabilise. However, other constraints could keep the Fed’s policy rates low in the long run.
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