Write Your Congressperson! (If You Want Higher Interest Rates)
Many Americans would like interest rates to be higher. As I well know, they generally express that desire to Fed officials (and even former Fed officials like me). But they’re talking to the wrong people: they should instead write their Congressperson.
Now - I understand why they think that they should talk to the Fed. After all, the dominant policy conversation about the Fed treats it as having the Wall Street mission of determining the level of short-term interest rates. But this is conceptually wrong. The Fed is charged with the Main Street objective of ensuring that prices are stable and employment is at its maximum. It is then up to markets to determine the level of interest rates that are needed to accomplish those goals. To hearken back to the language of this prior post: markets set r* and the Fed’s job is to keep r equal to r*.
Right now, the Fed has set short-term interest rates (that is, r) low by historical standards. But inflation and household employment are both too low, and expected to remain too low for several years, relative to the Fed’s goals. It seems like r is still too high relative to the market’s determination of r*. How can this be? The answer is that as low as the Fed’s instrument r is by historical standards, the market-determined r* is even lower by historical standards.
I’ve said that markets determine r*. But Congress’ choices can affect r* in a number of ways. In particular, Congress can increase r* by taking any a number of actions that would stimulate more demand by people, businesses, or government.
Some fear that demand stimulus would provide only a fleeting benefit to the economy. But many actions that generate demand in the short-term would also be beneficial for supply in the longer run. For example, (well-chosen) government expenditures to augment and repair physical infrastructure like roads, bridges, and hospitals would have long-term benefits for society. Reduced taxation of business investment (especially R&D) would lead to more investment demand and to more growth. Of course, any kind of extra current demand for goods and services by the private or public sector would help increase the employment of younger Americans. That in turn would increase their longterm productivity.
In sum: right now, it seems like the Fed should lower, not raise, interest rates in order to achieve its mandated price and employment objectives in an appropriate time frame. But there are many steps that Congress could take that would allow the Fed to raise interest rates safely. So, if you want higher interest rates, don’t complain to the Fed. Write your Congressperson!
N. Kocherlakota
Rochester, NY, January 19, 2016
Please address media enquiries and non-academic speaking requests to Monique Patenaude (monique.patenaude@rochester.edu and 585-276-3693).