Fed keeps interest rates low, hurts ability to raise rates?

How will the fed keep the U.S. sustainable?

At the National Commission on Fiscal Responsibility and Reform in Washington, D.C. this week, Chairman Ben Bernanke spoke more optimistically than last year and noted a continuation of interest rates near zero where it will stay for an extended period.

In Bernanke’s speech, he said, “Economic activity has continued to strengthen and… the labor market is beginning to improve.” Bernanke noted that employers’ hesitance to hire is among the most problematic parts of the current economy.

Achieving long term fiscal sustainability

“Achieving long-term fiscal sustainability will be difficult, but the costs of failing to do so could be very high. Increasing levels of government debt relative to the size of the economy can lead to higher interest rates, which inhibit capital formation and productivity growth–and might even put the current economic recovery at risk.

To the extent that higher debt increases our reliance on foreign borrowing, an ever-larger share of our future income would be devoted to interest payments on federal debt held abroad. Moreover, other things being equal, increased federal debt implies higher taxes in the future to cover the associated interest costs–higher taxes that may create disincentives to work, save, hire, and invest.

High levels of debt also decrease the ability of policymakers to respond to future economic and financial shocks; indeed, a loss of investor confidence in the ability of a government to achieve fiscal sustainability can itself be a source of significant economic and financial instability, as we have seen in a number of countries in recent decades.

With interest rates remaining low, critics worry that the Fed will ultimately lose the ability to increase rates when the market can bear it.

Advertisement. Scroll to continue reading.