Richard Koo, Chief Economist at Nomura, suggests that avoiding “big messes” will require the Fed to proceed with the normalization of monetary policy before private-sector demand for funds recovers in earnest. Key Quotes “As long as loan demand remains weak, the probability of a steep rise in long-term rates as the Fed normalizes policy can be reduced. I suspect the Fed’s decision to begin tapering when inflation was only 1.1% and to raise rates when it was at just 1.3% reflects a desire to normalize monetary policy before private-sector funds demand recovers in earnest. It would ordinarily be out of the question for the central bank to hike rates at a time when the private sector is still saving 6.4% of GDP (with interest rates at zero) in a lingering symptom of the balance sheet recession. But if the Fed is to avoid the big messes it is concerned about, it should probably push ahead with normalization now, when the private sector is still saving 6.4% of GDP a year. The Fed still faces an extremely difficult decision inasmuch as the recent tendency has been for “small messes” to develop into “big messes” quite easily. The Fed’s projection in last week’s FOMC statement that economic conditions will “warrant only gradual increases in the federal funds rate” probably reflects this dilemma.” For more information, read our latest forex news.