We Want to Hear From You: Should the U.S. Federal Reserve Keep Interest Rates Low?

After their meeting yesterday (Tuesday), U.S. Federal Reserve policymakers said they are more worried about deflation than inflation and vowed to look for ways to help along an economy that is experiencing worrisomely slow growth.

In fact, the central bank's rate-setting Federal Open Market Committee (FOMC) said it plans to keep the benchmark Federal Funds rate at its record-low level unchanged between 0.00% and 0.25% for the 20th consecutive month. And, central bank policymakers said rates could remain that low for "an extended period."

In the near term, that appears justified. Core inflation is running at just 0.9%, below the Fed's comfort-level target of 1% to 2% – where it says the inflation rate needs to be for price stability. Fed Funds futures at the Chicago Board of Trade (CBOT) now show that traders believe there is a 54% chance the Fed won't increase short-term rates until its November 2011 policymaking meeting.

In the interim, faced with a still-wheezing economy, the central bank may even start buying back large blocks of U.S. Treasury bonds – a technique that pushes liquidity out where its needed.

"The question for Fed members is, to what degree can monetary policy help the economy grow from here?" Dan Greenhaus, chief economic strategist at Miller Tabak & Co., told Bloomberg.

The Fed has kept interest rates near zero since December 2008. Keeping interest rates low to spur growth started during the Asian Contagion in 1997, when currency devaluations spread rapidly through Southeast Asia. Markets plunged, as did consumer and investor confidence, and foreign economies adjusted policies and lowered rates to regain footing.

Those lower U.S. interest rates contributed to the dot-com bubble that took off in the late 1990s: Startup money became easy for venture capitalists to obtain, fueling a speculative mania in Internet stocks that crashed in 2000.

When artificially low interest rates combine with rising standards of living, speculative bubbles form. Some analysts and economists have said long periods of low interest rates contributed to the U.S. housing bubble, and fear that another long period of ultra-low interest rates will eventually create more asset bubbles that will disrupt the healthy economic patterns to which the United States needs to return.

Still, the Fed is hesitant to raise rates amid weak economic data. A report released Monday by the National Bureau of Economic Research (NBER) concluded that the most recent recession ended in June 2009. But economic growth that slowed to a 1.6% annualized rate in the second quarter has escalated fears of a "double-dip" recession. Unemployment remains at a stubbornly high 9.6% and is projected to stay above pre-recession levels until 2013, according to a report released this week by the Organization for Economic Cooperation and Development (OECD).

"The longer you have weak growth the longer you have no underlying healing in your economy," Ethan Harris, head of North American Economics at Bank of America-Merrill Lynch, told Bloomberg News. "You don't heal the housing market, you don't heal the household balance sheet. By allowing growth to sit below trend, you create a huge window of vulnerability to a shock."

This brings us to the next installment of the Money Morning "Question of the Week": Should the Fed be looking to raise interest rates a lot sooner than is currently planned? Has this long stretch of near-zero interest rates already sown the seeds of another speculative problem down the road? Or is the central bank on the right path, understanding that a boost in rates now will thwart an already tepid and uneven recovery?

Send your thoughts, questions and concerns to mailbag@moneymappress.com.

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News and Related Story Links:

• Money Morning:
  Will The Fed Fall Back on Treasury Purchases to Fuel Economic Growth?
• Bloomberg:
  Fed Prepared to Ease Further to Revive Economy
• The Wall Street Journal:
  Fed Worried, but Defers Action
• Money Morning News Archive:
  Question of the Week Feature