The Interwebs were lit up with talk yesterday regarding the new blog of former Fed Chair Ben Bernanke, currently at the Brookings Institute. Mr. Bernanke wrote his first blog about interest rates, clearly defending the role of the Federal Open Market Committee (FOMC) during his tenure. Make no mistake, Bernanke and his colleagues were going to err on the side of being too loose rather than too tight.
While their policy was far from perfect – the outcome of quantitative easing was definitely an unknown – many complained about the low savings rate available to investors (particularly seniors, a generation of savers). Mr. Bernanke offers a succinct rebuttal for keeping rates low at a most critical time during the crisis and recovery:
When I was chairman, more than one legislator accused me and my colleagues on the Fed’s policy, setting Federal Open Market Committee of “throwing seniors under the bus” (to use the words of one senator) by keeping interest rates low. The legislators were concerned about retirees living off their savings and able to obtain only very low rates of return on those savings.
I was concerned about those seniors as well. But if the goal was for retirees to enjoy sustainably higher real returns, then the Fed’s raising interest rates prematurely would have been exactly the wrong thing to do. In the weak (but recovering) economy of the past few years, all indications are that the equilibrium real interest rate has been exceptionally low, probably negative. A premature increase in interest rates engineered by the Fed would therefore have likely led after a short time to an economic slowdown and, consequently, lower returns on capital investments. The slowing economy in turn would have forced the Fed to capitulate and reduce market interest rates again. This is hardly a hypothetical scenario: In recent years, several major central banks have prematurely raised interest rates, only to be forced by a worsening economy to backpedal and retract the increases. Ultimately, the best way to improve the returns attainable by savers was to do what the Fed actually did: keep rates low (closer to the low equilibrium rate), so that the economy could recover and more quickly reach the point of producing healthier investment returns.
Hence, the sacrifice of one group may have been done to meet the greater good. That doesn’t make it right, but think about the consequences of raising rates prematurely. The Fed didn’t blink, and the economy is on much better footing. They will rarely,if ever, get credit for that.
Mr Bernanke ended with this very important note:
The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns.
You can read more his blog here: Why are interest rates so low?.
