The Patriot Post® · The Next Chapter in the Fed's Malaise

Months of speculation about the Federal Reserve’s plans for interest rates came to an end as the big bank finally announced Wednesday an increase in its target for the federal funds rate. It’s held a near-zero standard for a very long seven years, though it forecasts continued “gradual adjustments” in the months and years ahead. Unfortunately, the change is unlikely to quell market fears or instill greater consumer confidence.

Through the Ben Bernanke years and well into the term of Chairman Janet Yellen, the Fed has held rates at or near zero in an attempt to boost an any-time-now roaring economic recovery that has never come to pass. The zero-interest-rate plan, coupled with the quantitative easing schemes designed to shovel money into banks to make more loans, fooled the market for a time. Commodities, emerging markets, junk bonds and stocks apparently did well, though their activity never led to the economic breakthrough that Barack Obama and his economic brain trust promised or that investors yearned for.

Now these very same markets are feeling anxious, recognizing for some months now that the zero-interest-rate joy ride was about to come to an end. They have been dialing back their investments as they foresee the end of the bubble. Commodities are dropping and fears of wage-price pressures are on the rise.

The question that worries a seemingly conflicted Fed is whether the jittery markets are merely an anticipation of an economic course correction or a sign of a credit crunch in 2016. The final answer, whatever it may be, is unlikely to vindicate the Fed’s strategy over the last seven years or its reasoning for continuing to stay the course even while its wisdom has been disproven in the markets.

Sen. Ted Cruz (R-TX) is one of the few politicians (Rand Paul being an even more vociferous critic) who has had the will to call out the Fed for being at the heart of continued economic stagnation. “In the summer of 2008,” Cruz said, “responding to rising consumer prices, the Federal Reserve told markets that it was shifting to a tighter monetary policy. This, in turn, set off a scramble for cash, which caused the dollar to soar, asset prices to collapse, and CPI to fall below zero, which set the stage for the financial crisis.”

Cruz maintains that responsibility for the drag on the economy lies with the Fed because it never adopted the goal of stabilizing nominal spending growth. National Review’s Ramesh Ponnuru adds that by keeping spending expectations stable instead of letting Washington go on a spree, the Fed could have tempered expectations and reduced the need for quantitative easing. Ponnuru explains, “What the Fed got wrong in 2008 wasn’t just that it didn’t lower its target interest rates rapidly enough to chase the natural interest rate downward; it’s also that its tardiness and its signaling that it was concerned about a non-existent threat of inflation pushed the natural rate downward.”

On top of that, writes the Heritage Foundation’s Norbert Michael, “During the crisis, the Fed departed from pure monetary policy — i.e., providing liquidity to the entire banking system — and engaged in direct lending to financially troubled firms. These so-called emergency loans amounted to federal bailouts. And because they rescued firms from the consequences of their bad decisions, the loans are likely to encourage more bad loans in the future.”

As Cruz and Ponnuru note, the Fed may be trying to negotiate its way through a crisis of its own making, a sentiment echoed in The Wall Street Journal. If the Fed had started bumping up rates earlier in the recent economic expansion, mild though it was, investors might be more confident about the return to higher interest rates.

But the Fed wanted to see a big boom, apparently holding out for a 2% to 3% economic expansion. Now that it is clear such an economic breakthrough is not going to happen (without a change in the White House), the Fed not only has to admit to its poor judgment, it has to face the consequences of an even more volatile market. But given the ideological bent of those pulling the strings, expect the wrong intervention to continue.