Fed keeping interest rates artificially low is not working

The longtime gambit of the Federal Reserve to bring breath life into the economy via low interest rates is a bipartisan fiasco. When Ben Bernanke was the Fed chairman, having been appointed by George W. Bush, he went all-out with the idea that the Fed had a dual charge of not only maintaining sound money but also battling unemployment. To that latter end, Bernanke was convinced he needed to keep interest rates ridiculously low until the economy perked up to his satisfaction.

Now Barack Obama has appointed Janet Yellen to replace Bernanke, but on the interest rate front, nothing has changed. The Fed under Yellen's leadership continues to keep interest rates far below what the market suggests they should be. And while we did just have one solitary quarter of healthy growth and unemployment is down to 6.2 percent, a deeper look at the numbers tells us the Fed's interest rate gambit is making things worse, not better. The Wall Street Journal explains:

Less cheerful was the news on average hourly earnings, which increased by only a penny to $24.45. Hourly pay is up only 2% for the last 12 months, which is less than the 2.1% increase in the consumer price index in the 12 months through June. This means many workers are losing ground even when they are working. It's cold comfort for Americans to hear that inflation is well contained because their wages aren't rising even as food and energy prices increase. The jobs numbers continue to show the paramount need for faster economic growth. On this point Federal Reserve Chair Janet Yellen is right, and we haven't been among those fretting about a near-term inflation breakout. The bigger worry is more years like the last five of a lackluster 2.1% expansion.

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Where we disagree with Ms. Yellen is that more months or years of near zero-interest rates are the recipe for faster growth. As Stanford's Ron McKinnon has argued, the zero bound has distorted decisions about the allocation of capital. And the Fed's monetary exertions have led to excess bank reserves that haven't translated into the greater lending that many predicted. Getting off the zero bound would not mean a premature monetary tightening. It might even increase monetary velocity by inducing more bank lending. The Fed could find it does better by jobs and growth by a more rapid return to monetary normalcy.

Perhaps it reflects our emerging status as a nation of debtors that so many people hear "low interest rates" and automatically think that's a good thing. It's not necessarily a good thing at all. Low interest rate punish savers, who don't earn as much return on what they save. They also punish banks, and maybe you think that's fine because you see banks as greedy money grubbers. But we found out in 2008 what happens when our financial system is not stable. Banks need to be able to lend at market-driven rates if lending is going to be a profitable exercise for them. If it's not, then credit is going to be harder to come by and the average person may have a hard time understanding why. There is another reason low interest rates are not always good policy, and it speaks to the issue of government borrowing. Much of Washington's borrowing is short-term, and when notes mature, politicians turn around and refinance at current interest rates. When the Fed keeps interest rates artificially low, it allows politicians to mask the true cost of their borrowing because they're not giving creditors the type of return the market would suggest they should. Eventually, interest rates are going to have to return to normal, and when that happens the taxpayers are going to get quite a shock when the next round of debt refinancing hits. If more people were saving as opposed to borrowing, you would see more people questioning the Fed on this. They're not causing the economy to grow, and in the meantime they're depressing wages even as they give politicians cover for the true cost of their deficit spending. And none of this is helping to ensure sound money. The Fed really needs to stop manipulating both monetary policy and interest rates, and let markets work. I don't expect Janet Yellen to do that, but she should.