Lowering interest rates is not necessarily a bad thing. It can make borrowing cheaper, which – at least in theory – will stimulate business investment. It can weaken the dollar, making American goods cheaper abroad. It can lower payments on the federal debt.
The problem with lowering interest rates is that eventually they have to be raised again. If rates were to remain at zero indefinitely, the Federal Reserve Board could not lower them to stimulate the economy during a recession, unless it created negative interest rates, which cause a whole new set of economic problems.
And history says a recession is likely to come sometime soon. The current recovery, which has frequently been described as anemic, celebrated its eighth anniversary in June. Now in its 97th month, it is the third longest recovery on record. The average recovery since the end of World War II has been 58 to 61 months.
While the length of the recovery may not determine how long a recovery will last, when unemployment drops low enough to spur inflation, the probability of a recession climbs. And unemployment is allegedly at a 16-year low of 4.3%.
“Expansions, like Peter Pan, endure but never seem to grow old,” according to Fed economist Glenn Rudebusch.
But the current expansion has much more in common with Peter Pan. It’s a fairy tale. And the Fed has run out of fairy dust.
The Fed’s Conundrum
The conundrum the Fed faces is that as it raises interest rates so that it will be able to drop them in case of a recession, it may actually cause one.