A spooky forecast for the future of interest rates The Fed is facing a new debate over where it will raise rates next, with policymakers wary of another global financial crisis while markets are at their core.
The Fed has held interest rates near zero for more than a decade and has never before raised them more quickly than it is now, under its ultra-cautious, extraordinary-duress policy known as quantitative easing. All of that has created a situation in which some banks have higher capital and liquidity requirements than others, which in turn creates more of a risk-premium than a return-on-investment for all banks.
What this means is that while the Fed is pumping more money into the economy, it’s also putting a premium on the relative riskiness of the banks, setting up a self-fulfilling prophecy that they’ll end up with less capital and more capital-intensive businesses, setting the stage for another financial crisis. The real question for the Fed—and ultimately its members—is whether they should raise rates at all.
Since the financial crisis of 2007-08, all of the Fed’s rate hikes have been under conditions of near-zero yield and low inflation. Yet the Fed’s policy still raises short-term interest rates. In a paper written with Greg McBride, a scholar at the Washington Institute for Near East Policy:
If inflation is 2 percent and the Fed continues to hold rates near zero, the policy of raising short-term rates will, after some months, create greater risk-aversion and dampen the economy.
“They are a bit at odds with what the Fed would want,” says David Yergin, president of the geopolitical division at IHS Global Insight, a research and consulting firm focused on defense, international business, and government issues. “We had higher interest rates in 2009. Now, if the Fed were raising rates and
