Starting with the annoying first, interest rates are a not a policy! Nor does the Fed “set” them as in an edict. There was a time that the Fed could manage its inflation target (more or less the policy recently) by pegging interest rates – influencing credit conditions by performing the necessary OMOs to achieve the desired result. That does not mean that interest rates have anything to do with the stance of monetary policy other than a side effect. If you are one of those “interest rate addicts” rip the notion that the Fed sets interest rates as a policy right out of your head, turn your brain inside out, and repeat after me as I quote from Milton Friedman:
Low interest rates are a sign that money [monetary policy] has been tight.
Interest rates are a side effect of monetary policy. They are not a policy or even THE policy.
If you need evidence, here is some anecdotal evidence to chew on:
Suppose you are a Fed governor and your tool of choice is the traditional tool of managing interest rates to achieve your target; and all of a sudden your tool of choice is impotent (the ZLB). No one wants positive interest rates back more than the Fed because all those supposed intellectuals in their ivory towers are really just like everyone else – they’ve served their time in the trenches to get to the top and would rather not have to do actual work once there. They would rather have the drama over a quarter point in one direction or another of the old days just not if it means having to figure out how to appropriately manage monetary policy in crisis and navigate the political minefield that goes along with it. Hence we are still at the ZLB – there are no “official” monetary cookbooks that tell them how to deal with it and very little thought leadership on the FOMC.
Ever hear of the Peter Principle? But I digress.
It would have been much better for everyone on the planet if we had not ended up at the ZLB because the Fed allowed its policy to become tight out of becoming distracted by spiking energy prices – but we are there nonetheless. Interest rates are not “artificially” low. How I wish it were so.
Getting off that soapbox to jump on another, I am disappointed in the Fed announcement today. It has a very nasty habit of following instead of leading, looking and waiting for the confidence fairy to emerge and make all of its ongoing mistakes disappear. The government just passed a massive tax increase and spending cuts are on the horizon, and they sit there waiting for market turmoil to do anything. How about needing to offset this stuff? All we got was a big goose egg and a pile of excuses… but they are still watching… and waiting…