The US Federal Reserve has held interest rates at near zero levels since December 2008 and the interest rate has not been raised for nine years now. Rates were lowered in a bid to stimulate the economy by reducing the costs to businesses of taking out loans needed for expansion. In the event, because of the nature of the Global Financial Crisis, much of this cheaper money was used to improve balance sheets at banks such that they could withstand a “Son of the Global Financial Crisis” catastrophe without needing a bailout from the public coffers to keep them afloat. Banks were reluctant to lend to businesses and, in turn, businesses were wary of expanding until they were certain that demand merited it. This partially explains why the global recovery has been a relatively weak and drawn out affair and goes some way to explain the near-panic that has swept global stock markets on the news that the Chinese economy is slowing down – however, growth approaching 7% in any other economy would trigger wild celebrations.
There was much speculation that US interest rates would rise following the meeting of the Federal Reserve earlier this month in a first step towards returning rates to their historical average values; a process which will take several years to achieve. However, weaker than expected job creation numbers for August and widespread concerns about the consequences of the slowing Chinese economy prevailed and a rate increase was delayed.
Speaking at the University of Massachusetts recently, Janet Yellen, Chairman of the Federal Reserve noted that US economic prospects “generally appear solid”. She explained that so long as inflation remained stable and the US economy was able to create enough jobs, conditions were right for an increase in interest rates by the end of the year. In classical terms, interest rate increases are used to “cool” an economy and rein-in inflation, but it is unlikely that an incremental rise in interest rates from such a low level would further constrict inflation which is also at historically low levels.