It appears there has been a significant shift inside the Federal Reserve.
In the minutes for the central bank’s Federal Open Markets Committee September meeting, several higher-ups at the Fed hinted that the policy of historically low interest rates was doing more harm than good to the economy.
The standard way of thinking of interest rates is that low rates incentivise lending and spending instead of saving. This gets money flowing through the economy and inspires hiring and economic growth. When inflation runs too high due to increased wages and prices, then you increase rates, slowing the economy and curtailing inflation.
That kind of thinking has led the Fed to maintain record-low interest rates for the years following the financial crisis. According to the release on Wednesday, however, this thinking may be changing.
One FOMC member said that the prolonged period of low interest rates was hurting pension funds and endowments, and that this may be hurting the economy. They said:
“Finally, one participant expressed the view that prolonged periods of low interest rates could encourage pension funds, endowments, and investors with fixed future payout obligations to save more, depressing economic growth and adding to downward pressure on the neutral real interest rate.”
This is similar to the argument against negative interest rates. Essentially, people are so concerned by the fact that the savings they do have are not earning much by way of interest, that they save a larger nominal amount in order to meet their retirement goals.
A few members thought that interest rates were so low that the Fed was about to let inflation get out of control and would have to act so fast that it would kill the economic recovery. Here’s the key passage (emphasis added):
“In contrast, a few other members were concerned that, without a prompt resumption of gradual increases in the target range for the federal funds rate, labour market conditions could tighten well beyond normal levels over the next few years, potentially necessitating a subsequent sharp tightening of monetary policy that could shorten the economic expansion.“
Finally, some members were concerned about the level of debt being taken out in the economy due to the low interest rates. Here’s that bit:
“A few participants expressed concern that the protracted period of very low interest rates might be encouraging excessive borrowing and increased leverage in the nonfinancial corporate sector.”
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