The Federal Reserve should consider reversing QE prior to raising interest rates.

Quantitative easing has radically altered America’s monetary policy framework with the injection of large amounts of liquidity into America’s financial system. Probably noteworthy of this exercise is that it was indicative of market failure, characterized by inefficient, or suboptimal resource allocation, in America’s financial system, since with the essential near zeroing of the Federal Reserve rate market participants, particularly banks, businesses and investors, were unwilling to move in the direction desired by the monetary authorities.

Proactively injecting liquidity into the financial system through quantitative easing resulted in liquidity in excess of what was desirable, if only as a means of transmitting the intent of the Federal Reserve at the time. Indeed, the dynamics of monetary policy for the Federal Reserve has not been left untouched as what seems to be a ‘new norm’ has arisen.

Rates remain close to zero, the system is awash with liquidity, the economy has regained a fair bit of traction, price movements seem more predictable with the volatility of oil factored, the dollar remains strong and although much remains to be accomplished, significant gains have been made in reducing unemployment.

The issue now commanding attention is whether and when to raise interest rates to stave off demand-driven inflation in wages and the major non-oil benchmark measures of inflation, and what would be the likely transformation and challenges resulting.

What is without question is that America’s economy has moved beyond its economic crisis and now definitely seems to have reached levels of economic activity where it seems prudent to intervene.

Probably the greatest challenge to overtly raising rates is the lack of viable alternative investments in the current depressed global economic environment. The global economy is awash with liquidity searching for viable returns, initiating increases in interest rates in America will very likely attract much of these funds. The effects of this are fairly predictable, and in the main, not particularly attractive, since this could work to check America’s recovery and the gains in employment by curbing its exports as a result of the likely strengthening of the American currency.

In this circumstance one of the issues to probably consider is whether the excess liquidity injected through quantitative easing has been withdrawn, and whether or not actively reversing this process seems to be the immediately more appropriate response. While this in itself will very likely put upward pressure on the dollar, the impact would probably be much lower and a bit more subtle.

Increasing interest rates without strengthening the dollar will very probably remain a challenge for the Federal Reserve and economics in the future.

CHINA'S Impact.

China will remain a specter to which the world will have to adjust as the country tinkers with aligning its economic model along the lines of those of typical advanced western economies. Its efforts to tackle corruption has drastically reshaped the thinking of decision-makers responsible for its public investment and capital projects to the point where these individuals are now reluctant proceed with the government’s expenditure as in times past. This has contributed to China’s slowing growth, which by some estimates is much steeper than reported.

China’s impact on policy implementation in America will hinge particularly on America’s dependence on China as a consumer, in addition to the potential psychological impact of China’s consumption and investment climate on that of the rest of the world. If anything, America’s intention to influence its domestic economic activity could be more tempered.