Circumstances in which the Federal Reserve announces a planned increase in short-term interest rates along with the reduction of mortgage-backed securities and Treasury bonds typically serve as an indication of a tighter approach to monetary policy. Even so, the recent announcement from Fed chairwoman Janet Yellen –- which featured the usual conditions associated with a tightening of the monetary policy –- outlined changes so incremental that the typical policy classification cannot be credibly applied in this instance.
Approximately nine years of monetary policy marked by the process of quantitative easing enabled the lower interest rates aligned with a period of sustained economic expansion across the globe. This period of expansion, of course, was preceded by a financial crisis that emerged out of the housing bubble and a relatively loose monetary policy. Arguments over the influence of the monetary policy tend to vary rather widely, but there are many who firmly believe that an earlier tightening of the monetary policy would have discouraged the borrowing that ultimately led to the housing bubble.
Nearly a decade later, those same arguments are being made in favor of a tightened monetary policy intended to ensure sustained economic growth rather than another downturn. Since many economic opinions closely align with one’s place on the political spectrum — which does not mean that the opinion is thus invalid or based on anything but sound reasoning — it’s important to remember the importance of objective economic analyses that take a wide range of issues into account to determine whether a particular action concerning the monetary policy will ultimately achieve its intended outcome.
The current state of the economy features businesses and households with fairly significant debt. An increase in the short-term interest rate, however incremental, might have a far greater impact on borrowers nationwide. With such widespread debt among American businesses and households, an interest rate hike could leave the Federal Reserve relatively helpless if the economy is suddenly dealing with another downturn. Legislators would likewise encounter difficulties in attempting to mitigate the consequences of another recession.
This is not to say that the Fed’s decision to change course — however slowly the change occurs — toward a tightened monetary policy will trigger a downturn; instead, it is important that policymakers take actions based on well-reasoned analyses that take into account the full breadth of factors that influence economic strength.
Thankfully, a reasoned approach to monetary policy is one of the areas in which ideology does not prevail over logic and reason. In fact, both The Roosevelt Institute and The National Review, bastions of liberal and conservative thought, have expressed a clear preference for a looser approach to monetary policy.
Even several prominent far-right politicians (including Ted Cruz, for instance) have gone on the record to say that the Fed’s recent approach, despite being regarded as loose by the majority of economists, inhibited economic growth in the aftermath of the recession because — in almost diametric opposition to conservative orthodoxy – the Fed’s monetary policy was not loose enough.
Keen observers of the decisions and debates surrounding economic policymaking should be heartened by the fact that the mistakes of the past are being heeded as the Fed takes steps toward tightening the monetary policy. That fact alone bodes well for a sustained period of economic growth.