Has the Fed waited too long to raise interest rates?
Critics of the Fed’s easy-money policies say they had diminishing impact over time and subjected the nation to side effects that could lead to serious problems in the future. Above, Fed Chairwoman Janet L. Yellen.
Reporting from Washington — Almost everyone agrees that the Federal Reserve’s extraordinary action to cut interest rates to near zero in the depths of the Great Recession helped save the country from a deeper downturn — or even another depression.
But as the Fed prepares to make a historical rate increase for the first time in nearly a decade, some critics question whether the central bank administered its monetary medicine too long.
They say the Fed’s easy-money policies, including huge bond purchases and a seven-year period of record low rates, had diminishing effect over time and subjected the nation to side effects that could lead to serious problems in the future.
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On Wednesday, Fed officials are widely expected to announce a modest 0.25 percentage point boost in interest rates, closing an unprecedented chapter in U.S. economic policy and leaving behind a legacy that historians will debate for years to come.
Critics say the central bank’s actions made Wall Street and the super-rich even fatter, fueling a stock market surge while leaving many ordinary workers no better off and widening the nation’s wealth inequality.
Stimulative policies begun under former Fed Chairman Ben S. Bernanke and continued by his successor, Janet L. Yellen, inadvertently channeled huge amounts of money into economic competitors abroad, including billions of dollars that bolstered China’s industries and exports.
And by flooding the global economy with cheap cash, the Fed’s prescription produced a frothy financial climate that encouraged speculative investment and excessive risk-taking.
As savers, pension funds and insurance companies sought relief from the pain of low interest rates, the issue now is “whether they ended up taking up risks that were greater than they realized,†said Donald Kohn, the Fed’s former vice chairman under Bernanke. “I think it’s too soon to know.â€
To defenders of the Bernanke-Yellen Fed, including Kohn, such complaints amount to Monday morning quarterbacking from critics who did not face the pressure to act quickly to avert disaster.
Moreover, they say many of the problems afflicting the present-day economy were developing all along and beyond the power of any Fed chair to cure. Income inequality and wage stagnation for the middle class, for example, have been building for decades.
And the Fed has had to stand largely alone, as most other developed nations struggled with their own financial problems and Congress and the White House became paralyzed by partisan politics.
The Fed has a dual mandate to maximize employment and stabilize inflation, which it tries to achieve primarily by pushing up or down the federal funds rate, the benchmark short-term financing cost for banks that influences a wide range of borrowing rates for households and businesses.
When Bernanke and his colleagues lowered the rate to near zero in December 2008 — it had been 5.25% just 15 months earlier — the financial crisis was in full swing. Wall Street brokerage Lehman Bros. had collapsed in September 2008, and job losses were mounting by the month, to more than 750,000 in November. Despite the Fed’s bland, understated statement of “further weakening†in the economy that accompanied the decision of the new rock-bottom rate, the significance of the moment was not lost in the discussions inside the Fed’s marbled headquarters.
“As you know, we are at a historic juncture — both for the U.S. economy and for the Federal Reserve,†Bernanke told his colleagues, later adding: “Today is the end of the old regime. We have hit zero. We can’t go further.â€
The Fed also undertook in late 2008 the first of three rounds of large-scale bond purchases, an unconventional stimulus in which the central bank essentially creates money to drive down long-term interest rates, thereby encouraging more borrowing and investments, particularly in more risky assets like stocks. A second round came in late 2010, followed by a third two years later, all of which fattened the Fed’s debt holdings to more than $4 trillion today.
Yellen and Bernanke, who stepped down in January 2014 after serving two four-year terms as chairman, have said they left interest rates at record lows because they did not want to act prematurely or risk hurting the halting recovery, particularly progress in the hard-hit labor market. U.S. economic growth has remained sluggish throughout the recovery, which officially began in mid-2009, but job growth has been fairly steady for more than three years. That has increased Yellen’s confidence that the timing is right to start the process of normalizing interest rates.
Bernanke and other Fed officials have frequently cited the effect of the Fed’s policies in stimulating car sales, which lately have been on pace to exceed a record 18 million units this year, nearly double 2009 levels. The average interest rate on a 48-month new-car loan dropped to 4.1% this summer from more than 7% at the end of 2008, though it’s changed little in the last two years.
“All these folks buying automobiles on pretty cheap credit, surely that’s helped put people back to work,†said Kohn, Fed vice chairman from 2006 to 2010 and who now works at the Brookings Institution, where Bernanke also holds a position.
Kohn said the Fed’s policies also aided the slower-to-recover housing market. On the whole, he added, without the Fed policies, the jobless rate would be higher than the current 5% and the inflation rate would be even further below the Fed’s 2% target.
Bluford Putnam, managing director and chief economist at CME Group, the world’s biggest futures market operator, agreed that the Fed’s near-zero interest rates and bond purchases helped stabilize financial markets and bolstered the economy — but only for a while. Putnam doesn’t think auto lending rates would have been much higher had the Fed begun to let off the monetary stimulus earlier. Consumer demand would have been there anyway, he said. And Putnam isn’t convinced that the Fed’s policies created jobs.
“When you step back and look at the whole picture, we just can’t find the evidence,†he said. Instead, the super-low interest rates helped bank profitability while leaving savers high and dry, he said. “It was a transfer of wealth from the retirees into corporations who didn’t use the money to create jobs,†Putnam said.
Bernanke declined to comment for this article, but in his book “The Courage to Act,†a memoir of the financial crisis published this fall, he acknowledges that it’s impossible to know exactly how much of the U.S. recovery can be attributed to the Fed’s actions. But he wrote that one reason to believe they were effective is that the U.S. economic recovery was much stronger than that of the Eurozone’s, where monetary and fiscal policies were much tighter than in the U.S.
During his tenure as chairman, Bernanke was acutely aware of the public’s deep resentment of the Fed’s emergency bailout of financial giants such as AIG as well as policies that inevitably favored the wealthy by spurring the stock market. One of the legacies of his eight years as Fed chief is how he dramatically opened up the communications of the once-secretive institution, appearing in town-hall meetings and interviews during which the onetime Princeton economics professor talked about his small-town roots in Dillon, S.C., and how he had never worked on Wall Street. (Since leaving the Fed, Bernanke has been an advisor to a large hedge fund.)
Bernanke frequently said that the Fed’s monetary policies were good for Main Street. But at the same time, the Fed’s stimulative policies helped fuel a surge in the stock market, which, even with the recent declines, remains far above pre-recession levels. With the wealthiest Americans better positioned to take advantage of the gains, the wealth of upper-income households in 2013 rose to 6.5 times greater than that of middle-income households, up from 4.5 times in 2007, according to the Pew Research Center.
The flow of cheap money didn’t stop in the U.S. Financial experts say it ended up chasing higher returns all over the world, especially in emerging markets, where investors supplied the capital for projects in places such as China and Brazil and contributed to the excesses in property markets including London; Sydney, Australia; and Vancouver, Canada.
“It’s even impacted the art market,†said Jack Ablin, chief investment officer with BMO Private Bank in Chicago, citing the auction sale this spring of a Picasso painting for a whopping $179 million.
More recently, capital has been leaving developing economies as investors look to the U.S. for higher earnings. That has shaken currency and financial markets and put new pressures on politicians and central bankers abroad.
Yellen and her colleagues held off raising rates this fall in part because of the shaky Chinese economy and uncertainties in international markets. That hesitancy intensified criticisms that the Fed’s aggressive stimulus policies — and now its plans for reversing them — were leaving emerging markets vulnerable to volatile streams of capital.
Adam Posen, president of the Peterson Institute for International Economics, said that some of the countries at risk, such as Brazil and Malaysia, were weak to begin with. And although some smaller economies may consider stronger capital controls to avert volatile investment flows, he said, “in the end, if either the U.S. or the Chinese economy undergoes a major shift [in monetary policy], it will have an effect. There’s no question about it.â€
On the legacy of the Fed’s seven-year run of record low interest rates, Posen said he thinks “it continued to do some good, though nothing as big as the first couple of years.†He said, however, there was “this wrong perception†that the Fed should have somehow resolved problems that have little to do with monetary policy. “It hasn’t saved us from bad fiscal policies or a productivity slowdown. It hasn’t saved us from a drop in the labor force,†Posen said.
Posen said he was disappointed not with the Fed but with corporate America. Despite the Fed’s extended easy-money policies, he said companies generally did not make a lot of capital investments, and instead used the low borrowing costs to fund stock buybacks and mergers.
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