To fix the debt, stop Fed rate hikes

The drumbeat for a rate hike by the Federal Reserve Board seems to be unstoppable. When the data seem to undermine one argument for a hike, the rate hike advocates simply change course.

The original rationale for higher interest rates was the need to stop inflation. We have had people harping on the risk of hyper-inflation since 2009. Inflation has remained stubbornly low these last six years, consistently remaining under the Fed’s 2.0 percent target. If anything, the recent trend has been downward as a result of the collapse of the price of oil and other commodities.

If the threat of inflation isn’t adequate for selling an interest-rate hike, the next move was the need to have higher rates to attack bubbles. The big problem with this story is that it is not clear that we have any bubbles, nor is it obvious that hiking interest rates is the best way to address them if we did.

House prices are high compared to their historic trend, but certainly well below their bubble peak on an inflation-adjusted basis. Cities such as San Francisco and Los Angeles are arguably seeing housing bubbles, but it would be rather bizarre to slow the nation’s economy in order to bring down house prices in a few cities where the housing market has gone a bit frothy.

The stock market is also somewhat high, but considerably lower after China fears knocked 10 percent off the values of the major indexes. Here too we can point to some tech companies such as Uber whose stock seems clearly over-valued, but do we want the whole country to suffer to provide a lesson to some Silicon Valley venture capitalists and their followers?

Then Fed Vice-chair Stanley Fisher argued that we should raise interest rates so that we can lower them if the economy falls into a recession. Since the key question is the current strength of the labor market and the economy, Fisher was effectively saying that we should deliberately weaken the economy now with higher interest rates, so that if some unseen event weakens the economy in the future, we will be able to respond with lower interest rates. That doesn’t sound very persuasive.

With the traditional rationales and their variations failing, we have gotten a new one: We should raise rates to show that we can. I suppose this case for a Fed rate hike can be taken as a modification of President Barack Obama’s famous campaign slogan, “Yes we can,” but it is not exactly an impressive argument.

While the proponents of rate hikes have been dancing around with their rationale of the day, the opponents of Fed rate hikes have been sticking with their stodgy line about not raising rates unnecessarily. They have made the point that the Fed should not be deliberately slowing the economy and keeping people from getting jobs in the absence of any serious inflationary threat. In fact, with inflation stuck well below the Fed’s target, there is a good argument that the Fed should be taking steps to boost the inflation rate.

But with proponents of rate hikes constantly changing their rhetoric, perhaps it’s time for opponents to offer a new reason as well. So here’s an argument against rate hikes to make all of those deficit hawks out there happy: Lower interest rates and higher employment will mean more tax revenue, less money paid out for unemployment insurance and other transfers, and therefore lower deficits. If we can sustain an unemployment rate that is 1.0 percentage point lower than the current 5.1 percent level, it could easily reduce the budget deficit by more than $1 trillion over the next decade.   

Low unemployment, not tax increases or spending cuts, was the main cause of our budget surpluses in the last years of the Clinton administration. If the Alan Greenspan Fed had followed the consensus within the mainstream of the economics profession and kept the unemployment rate from falling below 6.0 percent, we would have been looking at a budget deficit of around $250 billion (2.5 percent of GDP) instead of a surplus of roughly the same amount. 

In fact, rather than worrying about deficits, people in the low unemployment environment of 2000-2001 were worrying about what to do with the surplus. Alan Greenspan actually testified in support of President Bush’s tax cut as a way to avoid paying off the debt too quickly.

So another reason that the Fed shouldn’t raise interest rates is to keep the deficit and debt down. This should rally all of these Peter Peterson fiscal conservative deficit hawks. After all, don’t they care about the debt burden they are passing on to our children and grandchildren? What about that debt clock that is now ticking up near $18.4 trillion? Do they have a better way to reduce the deficit by a $1 trillion over the next decade?

Of course, these concerns about the debt are silly. Our children’s well-being is going to be determined by the strength of the economy that we hand down to them: the capital stock, the physical and natural infrastructure, the development of technology, and the education of the workforce — not sheets of paper (i.e. government bonds). But it is curious why the people who obsess over the deficit never seem to concern themselves with Fed policy which has a large and direct effect on the deficit.

At any rate, the main reason the Fed should not raise rates is that it absurd to have the government acting to deliberately keep people from getting jobs. The policy is especially pernicious since we know the victims of a rate hike will disproportionately be minorities and less-educated workers. But if we need an additional reason, we can always start yelling about deficits.