Raymond Richman       -       Jesse Richman       -       Howard Richman

 Richmans' Trade and Taxes Blog

Bernanke starting to raise interest rates
Howard Richman, 2/12/2010

Bloomberg.com reports (Fed in Talks With Money Market Funds to Help Drain $1 Trillion) that Federal Reserve chairman Ben Bernanke is planning to sell $1 trillion worth of short term US Treasury Bonds to money market funds. The Fed would take the money it gets from selling those bonds out of the monetary base and, in effect, burn it.

There are two things that can be deduced from this story:

1. Bernanke thinks that inflation will get started soon if he doesn't act.
2. Short term interest rates will soon go up from their current near-zero rates.

For the last two years (since Bush's stimulus package in February 2008), Bernanke has been, in effect, printing money in order to buy Fannie Mae, Freddie Mac, and US Treasury Bonds. He has been doing so to keep U.S. interest rates low.

Now he appears to be changing course. U.S. interest rates should start rising, and this could have the following effects upon the economy:

1. House Prices. Higher mortgage rates could cause house prices to fall.
2. Dollar Value. Higher U.S. interest rates could attract foreign savings causing increased demand for the dollar in foreign exchange markets. A higher dollar could, in turn, cause US imports to increase and exports to decrease.
3. Investment. Higher interest rates could discourage business borrowing for investment.
4. Durable Goods Purchases. Consumers often buy durable goods, such as cars and appliances, on credit. Higher interest rates could discourage these purchases,

All of the above four effects depend upon the amount that interest rates change. If they only go up a bit, then these factors may not be much affected. Also, if long-term interest rates currently include inflationary expectations, and if Bernanke's actions reduce inflationary expectations, then long-term interest rates could actually fall.

I am sure that Bernanke is following economic indicators quite closely. He, apparently, thinks that inflation is a bigger danger right now than a double-dip recession. His action is a sign of confidence in the short-term future course of the economy.