7 Reasons the Fed Should Raise Interest Rates…
...and Still Keep Easy Money Flowing through the Economy
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The Fiscal Times
June 29, 2012

Most economists reading the title of this article probably think I am an idiot. Easier money is what causes low interest rates and bringing down the rate of interest is the principal means by which the Federal Reserve eases monetary policy. So saying we need higher interest rates and easier money appears to be a contradiction in terms.
However, there is method to my madness. First, let me explain some of the reasons why we need higher interest rates.

1. Interest on savings is an important element of personal income. As rates have come down, the income of millions of Americans has fallen. It also reduces the incentive to save for retirement, the down payment on a house and other desirable purposes. As I noted in an earlier column, if people were still receiving as much interest income as a share of their total income as they did in 2008, they would have $450 billion more per year to spend.

 2. Low interest rates exacerbate the problems of defined benefit pension plans. They are required to discount their liabilities by the rate of interest rate. When rates fall, their liabilities go up because it raises the present value of future pension payments. Low rates also increase the incentive of pension fund managers to take on excessive risk in order to raise their rate of return. It would be much better if they had a risk-free form of investment, such as Treasury securities, in which they could invest and receive an adequate return.

3. Low interest rates and the perception that they will continue indefinitely, which the Fed has said it will do, discourages home buying. This may sound nonsensical, but it has been my experience as a buyer and seller of real estate that potential buyers are often motivated more by a fear that rates will rise than that prices will rise. I think the expectation of higher interest rates would force many potential home buyers off the fence and into the market.

4. Low interest rates keep energy and commodity prices high. This follows from the work of a famous economist named Harold Hotelling. If rates are high, miners and drillers will bring more out of the ground in order to invest the proceeds. But if rates are low, the opportunity cost of keeping oil in the ground is also low and so there is less incentive to bring it to market. Low interest rates have the same effect on other commodities by reducing the opportunity cost of holding stocks off the market in the hope of higher prices. If the expected increase in prices exceeds the rate of interest it is always in the interest of commodity owners to hold on to what they have.

5. The economist Joseph Stiglitz argues that low interest rates increase unemployment because businesses can cheaply invest in automation and labor-saving equipment. “Persistent low interest rates encourage firms…to use capital-intensive technologies, such as replacing low-skilled checkout clerks with machines,” he recently wrote.

Bruce Bartlett’s columns focus on the intersection of politics and economics. The author of seven books, he worked in government for many years and was senior policy analyst in the Reagan White House.