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St. Louis Fed President: Raise Interest Rates
St. Louis Federal Reserve President James Bullard is bemoaning the Federal Reserve’s near-zero rate policy and the effects it’s having on savers. Low interest rates will hurt, not help, the American recovery, he said.

Bullard, speaking Monday at the Union League Club of Chicago, said he believes the push for low rates is based on a fundamental misunderstanding of the cause of the recession. Most analysts believe there is a large “output gap” in the U.S. economy these days — a gap between actual and potential GDP — and that it’s exerting downward pressure on inflation. If true, that would give the Fed a good reason to keep interest rates low, he explained. But Bullard called this a misinterpretation of the facts, and went on to suggest that current monetary policy response could “be a looming disaster for the United States.”

“A better interpretation of the behavior of U.S.real GDP over the last five years may be that the economy was disrupted by a permanent, one-time shock to wealth,” he said, in prepared remarks. “In particular, the perceived value of U.S. real estate fell substantially with the 30 percent decline in housing prices after 2006. This shaved trillions of dollars off of the wealth of the nation.”

In this interpretation, our recovery wouldn’t be some rapid expansion of the economy one could peg to a season — recall the Obama administration’s Recovery Summer in 2010. Instead, Bullard expects the economy to simply “[grow] from that point” — the wealth shock — “at an ordinary rate, neither faster nor slower than in ordinary times.” And he argues that economic growth rates since mid-2009 back his interpretation up.

Bullard is concerned that policymakers, awaiting a speedy ramping up of economic activity, will keep interest rates low for years to come while waiting for economic output to reach unrealistically high levels. This, Bullard said, “punishes savers in the economy,” especially older Americans. No longer can they park their excess cash into risk-free investment vehicles and expect a positive real rate of return, explains Slate writer Matthew Yglesias, who is unsympathetic to this line of reasoning. Economic growth is what will actually help savers, he argues in another post: once there is demand for your cash, and banks can profit more from lending it out, they will give you more in return for letting them do so.

Currently, the national average APY for a 12-month CD is 0.58%, while the Fed’s target inflation rate is 2%, which Bullard claims is actually running above target at 2.4%. This means that savers get a negative real rate of return on their cash if they opt for risk-free investments. Anyone seeking better risk-free returns might be waiting for years.

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