Skip to main content

Cookies and Privacy

We use cookies to improve your experience on our website. To find out more, read our updated Cookie policy, Privacy policy and Terms & Conditions

barro6_ZachGibsonGettyImages_jeromepowellupset Zach Gibson/Getty Images

Is Politics Getting to the Fed?

In the early 1980s, the chairman of the US Federal Reserve, Paul Volcker, was able to choke off runaway inflation because he was afforded the autonomy necessary to implement steep interest-rate hikes. Today, the Fed is clearly under unprecedented political pressure, and it is starting to show.

CAMBRIDGE – From the early 1980s until the start of the financial crisis in September 2008, the US Federal Reserve seemed to have a coherent process for adjusting its main short-term interest rate, the federal funds rate. Its policy had three key components: the nominal interest rate would rise by more than the rate of inflation; it would increase in response to a strengthening of the real economy; and it would tend toward a long-term normal value.

Accordingly, one could infer the normal rate from the average federal funds rate over time. Between January 1986 and August 2008, it was 4.9%, and the average inflation rate was 2.5% (based on the deflator for personal consumption expenditure), meaning that the average real rate was 2.4%.

The long-term normal real rate can be regarded as an emergent property of the real economy. From an investment and saving standpoint, economic equilibrium balances the benefit from a low safe real interest rate (which provides low-cost credit for investors) against the benefit from a high real rate (which implies higher returns for savers).

We hope you're enjoying Project Syndicate.

To continue reading, subscribe now.

Subscribe

Get unlimited access to PS premium content, including in-depth commentaries, book reviews, exclusive interviews, On Point, the Big Picture, the PS Archive, and our annual year-ahead magazine.

https://prosyn.org/JhWIoc8;
  1. gros129_Thierry Monassepicture alliance via Getty Images_ursulavonderleyenEU Thierry Monasse/picture alliance via Getty Images

    What EU “Geopolitical” Power Will Cost

    Daniel Gros

    Ursula Von der Leyen, the new president of the European Commission, has promised to position the European Union as a geopolitical power that is capable of holding its own against the United States and a rising China. But the EU may come to regret any attempt to parlay its economic strength into geopolitical clout.

    12