The Federal Reserve could discredit all the unusual and unconventional monetary policies it has taken since the financial crisis if it botches the return to normal policy, a member of the central bank warned Friday in a novel argument for raising interest rates.
Loretta Mester, the president of the Federal Reserve Bank of Cleveland, said in a speech delivered in London Friday that if the Fed fails to “gracefully navigate back toward a more normal policy stance at the appropriate time,” there is a risk that unconventional tools would be “off the table” in future crises because the public viewed them ultimately as failures.
The nontraditional tools Mester was referencing include the Fed pushing its interest rate target all the way to zero and then engaging in large-scale bond purchases, or quantitative easing.
In addition to making the public think those efforts were a failure, Mester warned, waiting too long now to raise interest rates would also risk inflating a financial bubble or creating too-high inflation.
The Fed currently targets short-term interest rates at 0.25-0.5 percent, a low level by historical standards.
It has kept rates low because of concerns that inflation has run below its 2 percent target for years, a sign that the economy may be operating below potential.
But the signs from the labor market, Mester noted, signal that the economy is running hot, with unemployment below 5 percent. “From the standpoint of what monetary policy can do, I believe the economy is basically at maximum employment,” Mester said, according to prepared remarks.
Despite her concerns about keeping rates low, Mester, a voting member of the Fed’s monetary policy committee, did not dissent from the Fed’s June decision to keep rates steady. She explained that she voted for the decision because of uncertainty about the Brexit vote scheduled for just a week later.
The Fed’s next monetary policy meeting is scheduled for late July.
