The road back to monetary normal cannot be smooth

The official short-term interest rate as set by the US Federal Reserve has been in a range between zero and 0.25 per cent since December 2008. The Fed's chair, Janet Yellen, told a congressional committee last month that this rate would, on current expectations, be the subject of central bank tightening later this year.

Following Yellen's appearance in Washington, her Federal Reserve colleagues fanned out across the US bearing the message that official interest rates, which are the most potent weapon in the Fed's monetary arsenal, were going to be raised later this year.

This marketing blitz was aimed at reassurance that the policy change would be incremental, smooth and seamless.

Back in 1994, the Fed precipitated a financial crisis when it unexpectedly raised interest rates that had been set at the favourable level of 3 per cent to ease the US economy through the collapse of the nation's savings and loan system.

Compounding the pain involved in that surprise tightening was the Fed's decision to move the rate by a king-sized 75 basis points in one go. The Fed was, as they say, behind the curve and had to regain control of policy.

This proved to be a disruptive episode with global dimensions, as emerging economies had become quite active in the international bond market. The crisis in 1994 left a legacy of damaged corporations that were ill-prepared for the Asian contagion of 1997-98.

Globally there were a number of high-profile bankruptcies, the most prominent being Orange County, one of the most prestigious counties in California.

The lesson of '94 was not forgotten nor fully understood in May 2013 when the then chairman of the Fed, Ben Bernanke, gave a heads up to a congressional committee hearing that the Federal Reserve expected to begin tapering its quantitative easing program later in the year.

Financial markets were much more connected than had been the case in 1994. In addition there had been over the previous decade a quantum leap in global debt exposure across corporate, household and public sectors.


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Max Walsh


Max Walsh was for many years one of Australia’s top economic and political commentators, highly regarded as a journalist, author and broadcaster. Throughout his career, Max was involved in all dimensions of the media industry, which has encompassed positions with two of Australia’s largest publishing companies and television networks.

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