Money

How Long will the Fed Keep Interest Rates Low?

| by Institute for Policy Innovation

The days of Federal Reserve Bank independence from the political sphere may be drawing to a close. And given the Fed’s dramatically increased activism during the economic downturn, that may be a good thing.

While liberals complain that Republicans kept President Obama and Democrats from doing enough during the recession—that is, from printing or borrowing even more money—that criticism overlooks the many ways the Fed has intervened in the economy.
 
And it may not be finished yet, as Fed Chairman Ben Bernanke made clear last week, sending the Dow up sharply.
 
The stumbling block has been finding a sellable academic justification for continued intervention, which the Fed may now have.
 
The Wall Street Journal reported last week that Columbia economics professor Michael Woodford would be presenting a paper at the Fed’s annual retreat, in Jackson Hole, Wyoming.
 
According to the Journal, Woodford likes low interest rates and is trying to persuade Bernanke and the Fed to keep them that way. The problem is how to defend that action when many economists recognize that artificially low interest rates can spawn inflation and create economic distortions—such as encouraging people who can’t afford a house to buy one.
 
Undaunted by the problems such actions create, Woodford’s paper apparently suggests that the reason low interest rates have not been more successful in stimulating the economy is that they have been as perceived as short-term rates. If the Fed were to indicate that it will keep rates artificially low even after the economy recovered, Woodford contends, that would spur consumers and employers to borrow, spend and invest.
 
Of course, an indefinite easy-money policy would likely also spur inflation and create bubbles in the economy in which people or companies borrow money they have no real hope of repaying simply because it’s cheap—like, oh, for buying a house.
 
To date, the Fed has defended its easy-money policies because the Obama economy has been so slow. If it decides to embrace cheap money as a long-term strategy, it is likely to open the door for even more congressional criticism—and maybe even shackles.