The Federal Reserve has kept its main interest rates, which banks use to lend to one another and determine the cost of credit throughout the rest of the economy, at or near zero since December 2008. The central bank has maintained the low rates so as not to disrupt the country's recovery from the largest financial crisis and recession in decades.

But several current and former senior economic officials told the Wall Street Journal earlier this month that the virtually unprecedented, prolonged period of near-zero rates risks depriving the Fed of the “ammunition” to address the next recession -- let alone another financial crisis. The Fed's primary method of economic stimulus, they note, has traditionally been cutting interest rates, something that is not possible if rates are already so low.

That could force the government to rely disproportionately on fiscal stimulus, these experts warn, holding a recovery hostage to a partisan ideological divide that has paralyzed Congress and shows no signs of abating. 

None of the officials who spoke to the Wall Street Journal explicitly called for an interest rate increase in order to keep the Fed’s options open for the next crisis. The main reason that Fed officials publicly provide for a rate hike is still that they believe price inflation is on track to hit the Fed’s 2 percent target. (William Dudley, president of the Federal Reserve Bank of New York, signaled on Wednesday that the the Fed was reconsidering a September interest rate hike after several days of volatility in the stock market.)

But Fed watchers believe that a desire to replenish the Fed’s proverbial firepower for the next recession is part of the motivation of Fed officials who want to “normalize” -- i.e., increase -- rates.

Narayana Kocherlakota, the outgoing president of the Federal Reserve Bank of Minneapolis,vehemently opposes an interest rate hike in the near future. Kocherlakota nonetheless believesthat his central bank colleagues’ perception that low interest rates have given the Fed less “monetary policy ‘space’” will prompt them to raise rates sooner and higher than is desirable.

Jack McIntyre, a portfolio manager and senior research analyst at Brandywine Global, a Philadelphia-based asset management firm, also said those concerns are part of the Fed’s calculus. “Yes, the [Fed would] like to remove emergency-level monetary stimulus to build up ammunition for the next slowdown in the U.S. economy,” McIntyre told The Huffington Post. “It would be a net positive to move us off of zero interest rates to build up some ammunition so they can cut them when it slows down.” 

Many economists insist, however, that these fears are misplaced. They instead argue that the best way for the Fed to prepare for the next recession is to prevent the economy from slowing down too soon in the near term.

“I would much rather have the Fed engage in slowdown and recession prevention by getting us to reach levels at which a rate hike would not be premature,” Josh Bivens, research and policy director at the left-leaning Economic Policy Institute, said earlier this week.

If the Fed raises rates in the coming months to give itself leeway for the next recession, Bivens warned, it risks “creating the crisis you are trying to have tools to fight against.”

Bivens is one of a number of liberal-leaning economists and activists who argue that the economy is still far from full employment. They want the Fed to wait for widespread wage growth to take hold before raising rates, and they were in Jackson Hole, Wyoming, on Thursday and Friday to make their case to Fed officials directly.

When the economy slows down more substantially, Bivens said, the Fed could still stimulate growth using quantitative easing, the massive asset purchasing program it initiated during the most recent recession after interest rates had already bottomed out. 

There are other even less conventional techniques available to the central bank, like instituting negative interest rates, which would effectively charge banks for depositing their money rather than lending. It is an idea that former Fed chair Ben Bernanke told The Wall Street Journal has merit.

Richard Parker, an economist at Harvard, agrees with Bivens and other economists that middle- and lower-income workers have yet to share in the gains of the current recovery, but is less worried about the damaging effect of a rate hike.

Instead, Parker believes that lawmakers and activists concerned about low wage growth should focus on changing the regulatory and fiscal policies that he believes would have a bigger impact. 

Parker supports a “retained earnings tax” that would penalize corporations for hoarding cash for stock buybacks and other actions “meant to bolster share prices (and hence bonuses)” that do little for the real economy.

And while Parker acknowledges that partisan gridlock makes the prospects of pro-growth fiscal policy dim at the federal level, he sees the success of efforts to raise the minimum wage at the state and local level as a model for incremental progress. 

“It is beginning to look like the early Progressive Era, when states were the laboratories for democracy,” he said. 

Source: Huffington Post