Financial markets applauded the Federal Reserve this week when it straddled the fence on rate hikes, but the bigger message was the downgrade in its growth forecast to 2.5% in 2015. That means another year stuck in the weak "new normal" that began in 2009.
Yes, the stock market has reached record highs. But real median household income has fallen. It was more than $ 56,000 in 2007 but slumped to below $ 52,000 in 2011-13.
Near-zero rates and the Fed's rapidly expanding regulatory control of finance have put the Fed at the center of capital allocation. This has caused credit to gravitate to well-established borrowers, especially governments and large companies, at the expense of more growth-oriented savers and borrowers.
The Fed's belief that near-zero rates lead to growth is deeply embedded, but experience shows that growth comes from private sector dynamism, which thrives on market pricing, not artificially low rates.
On Wednesday the Fed stopped saying it would be "patient" about hiking rates. That's a nod to the interest-rate "normalizers," who argue that small rate hikes will increase loan demand (to get ahead of rate hikes), incentivize saving and lending activity, unfreeze the moribund interbank market, and begin to unwind the Fed's takeover of the market's critical role in capital allocation.
While that part of the Fed's statement was good, the Federal Open Market Committee (FOMC) had to lower its view of the appropriate level of 2015-16 interest rates due to falling expectations for growth and inflation. Wednesday's new Fed view showed slower growth and roughly one less hike each year than in December. It pointed to a 2% fed-funds rate at the end of 2016 rather than 2.5% in the Fed's previous view. That amount of normalization still would be pro-growth, but there's a risk that the Fed won't be able to get to rate hikes in 2015.
On Wednesday Fed Chair Janet Yellen emphasized that the Fed is data dependent, implying that the economy will have to do better to win rate hikes. Due to recent membership changes, the voting members of the FOMC are particularly inclined to keeping rates low. The problem is that the Fed's track record each year since 2011 has been to lower its forecast during the calendar year rather than raise it. If the economy again disappoints the Fed, the decision to hike rates will get harder as the year progresses.
The latest waffling over the timing of rate hikes has another negative effect. The Fed says it wants to keep reinvesting its staggering $ 4.5 trillion bond portfolio until after rate hikes get under way. That means more months or years with the Fed buying massive amounts of long-term bonds as short-term bonds mature. As a result, any delay in rate hikes keeps the Fed at the center of bond market distortions that much longer, slowing growth.
This is all happening in the context of weak foreign currencies and growth rates, referred to discreetly in Wednesday's FOMC statement. That provides another excuse for delay.
Last but not least, there was no hint in Wednesday's statement that the Fed recognizes its policies haven't worked well. By itself, that mental block adds to the risk of slower growth and further delays in rate hikes.
Mr. Malpass is president of Encima Global LLC.
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