Marcus Nunes has a new post that discusses a recent Wall Street Journal article. Here’s the WSJ:
The Fed needs to keep raising short-term interest rates to diminish risks to the economy and markets of “excessive accommodation,” Mr. Kaplan told the Journal on Monday. However, fragile and interconnected financial markets, slow global growth, and the perils of driving the economy back into recession all mean the Fed can’t move aggressively, he said.
“We want to try to normalize [interest rates] as fast as we can,” Mr. Kaplan said in a Dallas office stuffed with memorabilia from his home state of Kansas and with management “how to” books he wrote at Harvard. “But we have to be patient and gradual.
I was most struck by the term “normalize”. I was not aware that there was any normal level of interest rates. I’ve observed rates ranging from 0% to roughly 20%, and in some countries rates have recently gone negative.
Is this a harmless concept? I don’t think so. If the Fed is trying to normalize interest rates as fast as they can, then interest rates have become a goal of Fed policy, in addition to employment and inflation. And that means they are willing to trade off worse outcomes of employment and inflation in order to get better outcomes for interest rates.
I also see an even great danger. In the past, the Fed’s biggest errors occurred in the 1930s, in 1966-81, and in 2008. (And yes, Bernanke has now admitted the Fed should have cut rates faster in 2008.) In all three cases, interest rates were already “abnormal” and the appropriate policy was to make them even more abnormal. Now think about Kaplan’s view that the Fed should want to normalize rates as fast as possible. People holding that view in the 1930s, the 1970s, or 2008 would have been likely to make the exact policy errors that led to our greatest monetary disasters.
Maybe the Fed should try to control the variables that actually lead to economic instability, and let the market determine what level of interest rates is “normal.”
Another Marcus Nunes post discusses a recent post by Narayana Kocherlakota. Here’s Kocherlakota:
Notice that I have not said that the Fed should provide a collective forecast for its short-term interest rate target. Policymakers’ forecasts are inevitably seen as something akin to commitments. The Fed should be committed to delivering particular inflation and employment outcomes, not to a specific path for interest rates.
Exactly.
READER COMMENTS
Brian Donohue
Mar 25 2016 at 12:19pm
If by “normalize” he means flattening the yield curve and pushing real rates farther into negative territory, I guess I understand it.
MikeDC
Mar 25 2016 at 4:59pm
I mean, I understand the point, but I’d think a “normal” rate of interest is one that reflected a somewhat sustainable balance between current and future consumption.
Just at a gut level, 0 and negative interest rates make me want to go watch Children of Men and be depressed.
bill
Mar 25 2016 at 5:19pm
Kocherlakota is great.
There is one interest rate I wish they would “normalize”. Interes on reserves. 95 years at zero. 8 years in positive territory and now the Fed is raising it? That’s abnormal.
smiley face.
Rajat
Mar 25 2016 at 7:13pm
OT, but any views on Bernanke’s latest suggestion for the Fed to peg long-term interest rates http://www.brookings.edu/blogs/ben-bernanke/posts/2016/03/24-rate-pegs?rssid=Ben+Bernanke
I’m confused as to what effect this might have. If the policy is ‘credible’, could it be contractionary – because rates are kept low without increasing the path of the money base or the target level of nominal variables? And if it’s not credible, it might lead to the Fed owning all short-term securities but have little impact on nominal variables as it would be a temporary injection.
Dustin
Mar 26 2016 at 11:52am
Rajat,
Pegging a long-term rate sounds a lot like NGDP targeting.
Dustin
Mar 26 2016 at 12:10pm
Rajat,
Pegging a long-term rate sounds a lot like NGDP targeting.
SG
Mar 28 2016 at 4:43pm
Scott,
I used to wonder about the Fed’s interest rate obsession, but then I read the text of the Federal Reserve Act, and this is what I found:
12 U.S. Code § 225a – Maintenance of long run growth of monetary and credit aggregates
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
For better or worse, the Fed actually has a triple mandate, and the “interest rate” prong of that mandate really doesn’t make any sense, for the reasons you state in your post.
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