There was certainly a time and place for it: Most economists credit the Federal Reserve’s super-low interest rate policy, in effect since 2008, with reviving shell-shocked financial markets and breathing life back into the economy. But nearly seven years on, aggressive monetary stimulus may now be hurting those it’s meant to help.
Fed critics have long warned that the gusher of liquidity opened by the Fed will generate runaway inflation, which hasn’t happened. But there’s new concern that the abnormally low interest rates resulting from central bank quantitative easing are creating perverse incentives for many companies to deploy cash in ways that benefit the wealthy without doing much, if anything, for workers or ordinary consumers. “Flooding the system with more cheap money is the wrong solution,” former FDIC chief Sheila Bair recently told Yahoo Finance. “It has made income inequality worse. We need to get back to real economic growth, not artificially stimulated growth with cheap interest rates.”
Wall Street barons and other one-percenters have gained the most from super-low rates that have diverted a flood of money out of low-yielding bonds and into stocks and other risky assets, producing an epic bull market that’s now in its sixth year. But a growing chorus of one-percenters, including BlackRock CEO Lawrence Fink and hedge-fund billionaire Stanley Druckenmiller, argue that raising rates is now the best way to help workers still struggling to join the economic recovery.
The reasoning goes like this: Low rates make debt so cheap that companies are borrowing to finance mergers, acquisitions, stock buybacks and other types of “financial engineering” instead of investing in ways that boost the real economy and create jobs. Mergers and acquisitions tend to eliminate jobs as firms consolidate, rather than creating them as a company might by expanding a factory, purchasing new equipment or directly taking on new workers.
Recent research by economist William Lazonick of the University of Massachusetts Lowell argues that a surge in stock buybacks in recent years has “concentrated wealth among the richest households” while wiping out middle-income jobs that used to sustain many families. “Low interest rates are currently doing more to encourage buybacks than productive investment,” Lazonick says.
A doubling of corporate debt
Druckenmiller points out that the amount of corporate debt in circulation has doubled from $3.5 trillion in 2007—which we now know was the peak of the debt bubble that preceded the 2008 crash—to $7 trillion today, largely because low rates make it so appealing for companies to borrow. Much of the new debt on the market is rated below-investment grade, or “junk.” In a downturn, higher-than expected default rates on those risky bonds could leave unprepared investors shouldering heavy losses. “The risk of a credit bubble is extremely high,” Druckenmiller recently told Bloomberg. “If not addressed pretty soon, things could get pretty difficult three or four years down the road.” And just about every downturn hurts those living paycheck to paycheck a lot more than those with substantial savings.
The Fed faces a tricky task, needless to say, in gradually tightening its super-easy monetary policy without choking off a delicate economic recovery. Record-low rates have clearly helped consumers in ways the Fed doesn’t want to disrupt. They’ve fueled a robust recovery in car sales, for instance, and helped reduce mortgage costs for millions of home owners who have refinanced or purchased a home during the last several years. Liberal-leaning economists such as Paul Krugman think the Fed should keep stimulating until unemployment falls further and wages rise enough to help most workers stay ahead of inflation. That could still take a couple of years, at the current pace of recovery.
Defending low rates
Former Fed chair Ben Bernanke and others reject charges that the Fed has helped widen the wealth and income gaps. Bernanke recently pointed out in a blog post, for instance, that the forces making income inequality worse have been building for decades, while the Fed’s super-easy monetary policy has only been in place for about seven years. Debtors, who tend to be less affluent than creditors, benefit more from low rates, he asserts. On top of that, job growth has been strong during the last 15 months or so, which counters the idea that companies are shuffling money around instead of using it to create jobs.
The Fed seems poised to finally start raising short-term rates later this year, from zero all the way up to 0.25% (which would still be historically low). Fed Chair Janet Yellen has repeatedly promised that the Fed will move slowly and deliberately once it does start raising rates, retaining the ability to change course should a surprise patch of economic weakness warrant that.
Once the Fed does move, it might have less impact on the interest rates and job prospects affecting most ordinary people than the fervent debate suggests. “The Federal Reserve is not the sole factor and not even the most important factor,” says economist James Hamilton of the University of California at San Diego, who co-authored a recent paper on how Fed policy affects the real economy. “The key thing limiting what they can do right now is the global situation.”
With central banks in Europe and Japan now easing more aggressively than the Fed, low rates accompanied by low inflation and slow growth may persist well after the Fed starts to tighten. Of course, we won’t know until the Fed actually does it, and even then, Fed policies will remain divisive.
Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.