The Fed’s Interest Rate Hike Is Overdue

I am not the only one who thinks the Federal Reserve should have raised its target federal funds rate at its September 17 meeting, as they suggested they would do months ago, although opinion was mixed on whether the Fed would raise the rate, and whether it should.

The Fed is holding the federal funds rate near zero, which is holding all interest rates down.  The argument is that the economy is still showing weakness so the low rate is needed to shore up a sagging economy.

First, let’s look at the facts.  The Fed has been holding interest rates down since 2008, and the federal funds rate has been near zero (below 0.2%) since 2009.

Now, let’s look at the Fed’s argument.  They have been holding interest rates down for well over half a decade now to stimulate the economy, and it hasn’t worked.  So, they are going to keep trying that same policy that has not worked in the past.

There is an inverse relationship between interest rates and asset prices (and, therefore, an argument that the Fed’s low interest rate policy leads to asset price bubbles), but let’s see how financial markets viewed the Fed’s move.  Assuming that stock market movements are a response to the Fed’s announcement, the S&P 500 and DJIA both fell on September 17 after the Fed’s announcement, and continued their downward slides the next day.

Interest rates affect asset prices, but so does the longer term economic outlook, and the indication in financial markets is that the negative effect on the long-term outlook outweighs the positive effect of lower interest rates.  That is consistent with the lack of effective stimulus we’ve seen for more than half a decade now.

If a policy isn’t working, maybe it is time to consider a different policy.

Randall G. Holcombe is Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America: Building Out of a Crisis (edited with Benjamin Powell); and Writing Off Ideas: Taxation, Foundations, and Philanthropy in America .
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