Take your medicine: it's time for the Fed to bump the interest rate up

We’re entering into a period where there will be (hopefully) repeated discussions of whether or not the Federal Reserve should continue increasing the interest rate as the economy improves and unemployment bottoms out at whatever baseline number it manages to find. That’s going on this week, setting off the usual alarm bells. No sooner was it leaked out that the Fed was pondering another 0.25% bump than analysts reported that Wall Street was “wavering” or sliding or whatever other word you wish to apply. CNBC picked up on it immediately.

As I mentioned, this isn’t going to be a one time thing. Unless we hit another serious recession we should expect the prime interest rate to drift slowly back up to where it was the last time the economy was at least reasonably warm, if not boiling hot. All of these decisions have consequences and making an error in either direction can prove troublesome if not outright disastrous for all concerned.

Robert Samuelson has a worthwhile analysis of this phenomenon out this week which, while not providing any answers written in stone, at least lays out some of the benchmarks to watch for. The interest rate ever since the depths of the recent crash has been essentially zero. With the economy recovering, unemployment dropping and the market running like a jet engine, you might wonder why we would want to change anything. Samuelson points out that there are a number of factors to consider. One of them is the continuing stagnant nature of wages across the country which should certainly be doing better than they are. He also notes that an economy which runs too hot puts us in danger of a period of inflation which, when it gets out of control, can be just as bad or even worse than a moderate recession. But he also points out the opinions of some economists who think that the market should be allowed to “run free” rather than risk losing any ground we’ve gained. In the end, he settles for simply urging caution and making sure that the Fed doesn’t screw this one up.

Economist Josh Bivens of EPI likewise favors a “high-pressure economy” that would lead to bigger wage gains and stronger demand. But rather than feeding mostly into higher inflation, these pressures would “spur employers to boost capital investments and other drivers of productivity growth,” which would offset wage and price increases.

In other words: The Fed should give the economy “room to run” — meaning fewer interest-rate increases. Perhaps. But what seems sensible also could be wishful thinking. The lesson of the double-digit inflation of the late 1970s and early 1980s is that, once higher inflation captures popular psychology, it takes a crushing recession to purge it. That’s probably still true.

The stakes here are enormous. If the Fed gets it wrong, we will all pay.

Now that we’ve heard from bunch of actual economists, allow me to toss all that out the window. (And for the record, I’ve long maintained that they shouldn’t even teach economics in college anymore unless it’s placed alongside disciplines such as religion, voodoo and astrology.) From what little I’ve managed to learn trudging along at street-level over several decades, you rarely find people arguing for either side of this formula who don’t have a vested stake in it. Those low interest rates may have been necessary to pump a little sugar into the system of the economy after a crash of the size we saw in 2007 but the benefit it provides is not exactly evenly distributed.

Many economists refer to those at or near zero rates as “free money.” But who is it really free for? Major businesses can obtain loans at very little cost, but was anyone offering you a credit card with a 2% rate? (And by “you” here I’m talking about the consumer, not the captains of industry.) Yes, as the rates go up at the Fed your interest rates will bump up also, but borrowing money in any form has never been free in a truly free market capitalist system. Even more to the point, if you happen to have a savings account at your local bank or credit union, what sort of interest rate of you been getting lately? I can answer that one for you. It’s virtually nothing. Some of our younger readers may find this hard to believe, but when I was a young man you could get a passbook savings account that paid as high as 6% interest. If anyone was offering that today I can assure you that people would be bailing out of mutual funds based on the stock market in record numbers. But as it is, these bargain-basement interest rates have provided a tremendous disincentive for working-class people to save.

The list goes on, but there should be more than enough reasons for people to be supportive of slowly bringing the prime interest rate back up to a reasonable level. As soon as you hear about “free money” you should immediately begin looking to see who is waiting to pull the rug out from under you. There is no such thing as free money unless you live at the very top of the food chain. If the economy is truly on a sustainable path toward recovery then this is the long-awaited period of normalization we were told about. For better or worse, normalization includes going back to normal interest rates. And don’t panic over the stock market. Of course it’s going to shudder, moan and complain for a while but it’s done that forever and it will continue to go in the general trend it was already following. Wall Street responds to everything, up to and including whether or not the Kardashians get their television show renewed. This too shall pass.