Dec 30, 2018

The case against raising rates

Reproduced from Federal Reserve Bank of St. Louis; Note: Trimmed mean PCE inflation rate used as measure of inflation; Chart: Axios Visuals
Reproduced from Federal Reserve Bank of St. Louis; Note: Trimmed mean PCE inflation rate used as measure of inflation; Chart: Axios Visuals

Cal economics professor and OG blogger Brad DeLong took issue with my reasoning that the Fed was right to raise rates. He says that the recent stock market decline is "new information" that should have changed the Fed's mind — that, instead of raising rates this month, the Fed should have held them steady.

  • Brad is right that the stock market decline is new information, but it's new information that tells us more about stock-market volatility than it does about the health of the economy. The market does not deserve some kind of Fed-dispensed doggie treat just for bouncing around like a demented yo-yo.

Brad then says that interest rates can't have been artificially low, even when they were negative in real terms for almost a decade, because we haven't seen any inflation.

  • He's conflating two different things. Negative real interest rates can cause speculative asset bubbles even if they don't cause inflation.
  • Brad also thinks that "reserve and capital requirements"can "nip potential overleverage in the bud". But no one has come close to being able to apply such requirements to non-banks like private-equity shops and hedge funds, let alone corporations.

The bottom line: So long as inflation remains below its 2% target, critics will be able to make a credible case that rates should stay low. But how low is too low? (The current range of 2.25% to 2.5% is hardly high.) The question can also be posed a different way: How long is too long for real rates to be negative?

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