Prominent Economists Contend Now Is Not the Time for a Fed Lift-Off

While the Federal Reserve has sent mixed signals regarding whether or not it will raise the federal funds target rate at its September meeting next week, two prominent economists said on Wednesday that it would be a mistake for the Fed to raise rates at this time.

Kaushik Basu, Chief Economist for World Bank, said on Wednesday that the U.S. central bank should delay a rate hike until the global economy stabilizes. Basu said it would have negative consequences if the Fed raises rates now due to economic uncertainty in China and the effect it has on global markets. He told Financial Times that a September Fed lift-off would create a "major crisis" but said he believes it will cause some "immediate turbulence."

Meanwhile, former World Bank economist, Harvard president, U.S. Secretary of Treasury, and director or the U.S. National Economic Council Larry Summers wrote on his blog Wednesday that the Fed has to do what is "often hardest for policy makers. Stand still." Summers said the market currently estimates the chance of a rate hike at 34 percent and stated that "the case against a rate increase has become somewhat more compelling even than it looked two weeks ago," at which time stock market turbulence cause Summers to remark that it would be a "serious mistake" for the Fed to raise rates in September.

"If on the other hand, some portion of these fears are warranted and the Fed tips towards tightening, it risks catastrophic error."

Basu said a September rate hike by the Fed could result in a "shock" and subsequently result in a new crisis in emerging markets, since it would come back on increasing concerns over the Chinese economy which have grown since a currency devaluation by Beijing in August. If the Fed raises rates, Basu contends, it would lead to sharp swings in the currencies of emerging economies and that the strengthening of the dollar could be a hindrance to U.S. economic growth.

“The world economy is looking so troubled that if the US goes in for a very quick move in the middle of this I feel it is going to affect countries quite badly,” Basu said.

Summers brings up five salient points as to why he believes the case for a September lift-off has become less compelling:

• The markets have already tightened
• Soft data flow, including slow employment growth and falling commodity prices, seem to suggest that the U.S. and global economies are slowing and that inflationary pressures are reduced
• The argument as to why there should be concern about inflation breaking out is weak
• Arguments that the Fed can raise rates by 25 basis points without committing to a series of increases are "specious"; if a 25bp increase will have little effect on the economy, what is the case for raising rates?
• Conventional wisdom substantially underestimates current risks

"More likely than not, these fears are overblown and 2015 and 2016 will not go down in financial history," Summers wrote. "If so, and the Fed does not act, inflation will start to accelerate, volatility will subside and policy can step in. Regret may come in the form of inflation a few tens of basis points too high or a bit of euphoric relief in markets. If on the other hand, some portion of these fears are warranted and the Fed tips towards tightening, it risks catastrophic error."

Basu concluded that the "scenario is looking worse than it did even in June" because of volatility in the Chinese markets in the last two weeks as well as concern in emerging economies in case the Chinese economy takes a hit.

The Fed has not increased rates since 2006. The next Federal Open Market Committee meeting will wrap up on September 17, at which time the Fed will announce the decision on whether or not it will raise rates.