OPINION: Should the Fed stop influencing interest rates? – Stanly news and press

OPINION: Should the Fed stop influencing interest rates?

Posted 10:56 a.m. on Friday, September 16, 2022

The Federal Reserve (the “Fed”) is now raising interest rates. This is a tactic the Fed uses when it wants to slow the pace of the economy in order to reduce price increases. In other words, the Fed raises interest rates to reduce the rate of inflation.

Mike Walden

The Fed has followed the reverse interest rate policy during the pandemic. Then the goal was to increase spending and economic growth to combat the problems of the COVID-19 pandemic. The Fed cut its key interest rate – the federal funds rate – to almost zero. The policy worked as the economy rebounded strongly and returned to pre-COVID levels in early 2021.

But many economists believe that the Fed’s extremely low interest rate policy during the pandemic has led to the high inflation rates we are experiencing today.

Extraordinarily low interest rates and the money the Fed has effectively created to prop up those low rates has sparked a consumer buying spree that has outstripped the availability of products constrained by supply chain issues.

Therefore, the Fed’s low interest rate policy to deal with one problem – recession – led to another problem – inflation – and caused the Fed to switch to the exact opposite low interest rate policy. higher interest. Does this seem somewhat counterproductive to you?

It’s not just recent Fed policy that would lead many to answer “yes” to the question. It’s that we can see the same Fed policy used in previous years. For example, interest rates were very low before the subprime recession of 2007-2009.

The Fed raised its key rate to contain the surge in prices – especially house prices – which then caused the recession. To end the recession, the Fed lowered its key rate to almost zero, where it remained for several years. It’s a pattern we’ve seen over and over since World War II.

Why is the Fed following this policy of raising and lowering interest rates? The answer dates back to the 1930s when the country experienced the Great Depression. The Fed was then a young institution and it was strongly criticized for not having used its powers to fight the depression. Fearing that the country would face another depression after World War II, Congress asked the Fed to use its powers to keep unemployment low and prices stable.

Therefore, the real debate is whether the government – ​​particularly the Federal Reserve – should act to smooth out the ups and downs of the economy. That is, should the Fed take action to “cool down” the economy when it heats up and inflation rises? Moreover, should the government act to stimulate the economy when it is shrinking, unemployment is rising and businesses are failing?

It’s an old debate that also started in the 1930s. The argument for stimulating the economy when it’s down is easy to make, because people and businesses suffer when economic conditions is bad.

There is pressure on the government to spend money to reduce household suffering and keep as many businesses alive as possible. There is also support for the government to create the conditions that will allow the private economy to return. This is where the Federal Reserve’s policies of low interest rates and abundant monetary creation come into play.

But there are several arguments against an active role for government — and especially the Fed — in influencing the macroeconomy. The main complaint is that – rather than smoothing out the ups and downs of the economy – Fed actions may actually be contributing to those ups and downs.
Critics say look no further than today for an example. The COVID-19 pandemic generated a deep recession at the start of 2020. The federal government injected massive sums – by some estimates, more than $5 trillion – to support households, businesses and public institutions. The Federal Reserve has been a key player in this effort by using its power to create money and finance much of the $5 trillion by pushing its key rate to 0%.

Today, many analysts say that we are “paying” for these stocks with higher inflation rates, due to “too much money for too few goods and services”. As a result, the Fed reversed its policies and raised interest rates, reducing the money supply and creating the conditions for a possible recession.

There are other criticisms of the Fed’s active policies to guide the economy. The first is that its policies of lowering interest rates and creating money most help wealthier households who have financial investments – such as stocks and bonds – that benefit greatly from these policies. Additionally, when the Fed raises interest rates that could trigger a recession, job losses are concentrated among low-income workers, with many high-income jobs protected. Both of these impacts of Fed policies could contribute to greater income inequality.
Recognize that this debate over Fed actions sets up a very difficult choice. Should we let the economy take its course?

In other words, when the economy weakens – for whatever reason – and unemployment rises, incomes fall and bankruptcies rise, should the Fed follow a policy of “hands off” and let the economy heal itself? Also, should the Fed be passive when high inflation is a problem?

Or, should the Fed take an active role in managing the economy, even though the Fed’s actions are actually making the economy more unstable and unequal in terms of income?

These questions have been around for almost a century and they will not be resolved overnight. Yet we should review them periodically, have a debate and then decide.

Mike Walden is William Neal Reynolds Professor Emeritus at North Carolina State University.

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