There has been obsessive chatter about whether the Federal Reserve will, or should, raise interest rates this fall. At the Fed’s annual end-of-summer gabfest at Jackson Hole, Wyoming, the issue was topic A.
Advocates of a rate hike make the following claims:
Very low rates were necessary when the economy was deep in recession. Now, with growth up and unemployment down, the near-zero rates are creating speculative bubbles. They are not really stimulating the economy much, as corporations put cash into stock buybacks and bankers park spare money at the Fed itself. So, let’s get on with a more normal borrowing rate.
Opponents of a rate hike counter that the economy is a lot weaker than it looks. Wages are going nowhere. A lot of the jobs that have pushed down the nominal employment rate are lousy jobs. China’s economy has just hit a big wall, which will slow down global growth.
Raising rates will increase consumer and business costs across the economy — everything from home mortgages to credit cards to construction loans. There will come a time to raise rates, but we are not there yet. If anything, the Fed should find new ways to get money out into the real economy.
The Fed is famous for raising rates prematurely, seeing ghosts of inflation. But there is no inflation on the horizon — the bigger worry is deflation. In fact, the inflation rate is well below the Fed’s own target of two percent. And the Fed is the only game in town.
On balance, I think the opponents of a rate hike have the better argument. But consider for a moment that last assumption — that the Fed is the only game in town.
The larger issue, which is getting submerged in the great debate about raising rates, is that the Fed should not be the only game in town.
Normally, in a soft economy, the government would be using fiscal as well as monetary policy. But because of the obsession with deficit reduction — unfortunately shared by the Obama Administration (remember the Bowles-Simpson Commission?) — fiscal stimulus today is off the table; worse, deficit-reduction is contractionary. In plain English, prolonged deficit-cutting slows down growth.
With fiscal stimulus ruled out politically, pressure is on the Fed to be the sole engine of growth. Yet the central bank can only do so much.
There really should be three engines of government growth policy: monetary policy, fiscal policy, and long-term public investment. Conventionally, there are two: monetary policy, which is set by the Fed, and fiscal policy, via which government uses deficits or surpluses to stimulate growth or restrain an overheated economy.
When the Administration was promoting its stimulus in 2008, it used the language of counter-cyclical fiscal policy — let’s temporarily run a bigger deficit to make up for the shortfall in private purchasing power in a deep recession. Just to reassure critics, the administration spoke alliteratively of a stimulus that would be …read more
Source: More Fitness