ALLAN MELTZER: The Fed Is Making A Huge Mistake — It Needs To Raise Rates Now

What’s next after QE2? That question will be on everyone’s mind when the Fed’s two-day meeting ends Wednesday and Ben Bernanke holds his second-ever press conference.

What the Fed should do is “raise interest rates and start to reduce excess reserves,” says Carnegie Mellon professor, American Enterprise Institute visiting scholar and Fed historian Allan Meltzer.

Unlike Fed chairman Ben Bernanke, Meltzer believes inflation pressures are rising, citing rising raw material costs at the wholesale level. “The Fed just misses that because it plays a silly game with the Phillips Curve,” he says, referring to an economic theory that suggests employment moves inversely to inflation. In other words, because the job market remains weak, the Fed thinks inflation can’t take root.

Of course, what Meltzer thinks the Fed should do and what it will do are probably miles apart: “When QE2 ends…the Fed is going to continue to buy bonds necessary to hold interest rates low,” he says. “They’re continuing to make a great mistake.”

According to Meltzer, the “great mistake” the Fed is making is believing that more monetary stimulus — low rates and quantitative easing — can cure the economy’s ills. “We don’t have a monetary problem; we don’t have a shortage of liquidity,” he says. “Adding more reserves, keeping interest rates low is not going to do anything important for the recovery.”

Referring to his two-volume study, Meltzer says “my history shows it’s not unusual for the Fed to make mistakes. But they don’t usually make them as big as this one.”

This post originally appeared at The Daily Ticker.

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