Kansas City Fed: “Keep Interest Rates at Zero.”

The Federal Reserve currently holds interest rates in the U.S. near zero. Look at your own bank accounts to see evidence of this. The Federal Reserve keeps rates low through it’s asset-purchasing program, which I have described here. Low interest rates are supposed to encourage borrowing and lending, thereby theoretically stirring demand and stimulating economic growth.

For visual learners, examine this chart from the St. Louis Fed. This is the shortest-term paper I can find: 1-month AA prime commercial paper. We can see very clearly that short-term rates have been held near zero since 2009, when the Federal Reserve began its stimulus program. They have hardly risen over 0.25%.

fredgraph[1]

The U.S. economy has grown to rely on rates near zero. The capital markets are addicted to easy money. As soon as rates go up, we are very likely to undergo another recession. At that time, the Federal Reserve will have a choice: either re-inflate, bringing rates down to near zero and probably staving off the recession, or stay the course and allow a serious recession to afflict the U.S. Which choice sounds better? Most people would choose the first method: re-inflation and lowering rates. But this will not solve the problem. It will only mitigate the symptoms. The recession will not go away, it’ll just go to sleep for a while. It’ll be back. Until the markets are allowed to clear, which is what happens in a recession, the threat of recession is not likely to disappear.

Chairwoman of the Federal Reserve Janet Yellen has declared that she intends to raise rates not long after the Fed ends it’s asset purchase program, probably in mid-2015.  Kansas City Federal Reserve president Esther George has counter-declared, and rightly so, that raising rates quickly will have negative consequences. She wants a rate hike to be put off indefinitely. As Fox Business reports:

A top Federal Reserve official who has often warned of the risks of keeping U.S. interest rates too low for too long said on Friday she wants to see how winding down the Fed’s massive bond-buying stimulus goes before setting out any path for rate hikes.

“I don’t think it would be fair to say I have a date in mind or a path in mind,” for the appropriate timing of the Fed’s first rate increase, Kansas City Federal Reserve Bank President Esther George told the Central Exchange, a group of women professionals. “We are in a place now where we have to be very careful and think about how we are beginning to withdraw stimulus.”

The Fed has kept rates near zero since December 2008, and more than quadrupled its balance sheet to over $4 trillion with an asset-purchase program aimed at spurring borrowing, spending and hiring.

On Friday, [Esther George] said she continues to support the Fed’s reductions in bond-buying, and she also supports the decision to base any raise rates on a “wide range” of factors rather than use a specific unemployment rate benchmark.

But she also made clear that she differs from the majority of her Fed colleagues in wanting to keep rates near zero for a “considerable time” after bond-buying ends, and below normal even once employment and inflation reach healthier levels.

In other words, Esther George understands what I understand: the economy is going to experience severe convulsions when rates finally go up. She does not want a definite timetable to be set for a rate hike, because she knows that the economy will definitely never be ready for it.The markets have grown fat off of easy money and low rates. When rates go up, many of the investors and businesses who have made decisions based on an expectation of low rates are going to go bust. Unemployment will surge. The U.S. economy will slip back into recession. At that time, Janet Yellen will re-ignite the Fed’s inflationary agenda. She’s 100% dove. She’s worse than Bernanke. You can be sure she will leap at the chance to re-ignite an inflationary policy.

 

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