Thursday, October 8, 2009

Instability and Low Interest Rates

Australia has started to raise its interest rates. It is doing so in spite of having one of the highest central bank interest rates among major nations. But at 3 percent, it is the lowest rate ever seen in Australia and is considered an “emergency” rate there, so the increase to 3.25 percent has people breathing a little more easily there, and rightly so.

Super-low interest rates, below about 4 percent, serve to destabilize the economy, pushing investment money out of banks and into high-risk speculative investments. Sometimes, to be sure, that is what you need. You don’t want the economy to be completely stable when it’s in the doldrums — you want to shake it up a bit. But it is easy to underestimate the risks. Keeping interest rates artificially low for an extended period is like setting fire to your car in the hope that this will get the engine going again. It might work, but you’d rather not have to take the risks involved.

That, however, is what the Fed is planning to do. A Fed official hinted this week that the Fed might not raise interest rates in the United States until about two years from now. That, unfortunately, leaves more than enough time for a few well-funded investors to take some huge gambles that could create a worse recession than what we have already seen.

Last year I was calling for an immediate interest rate increase to 4 percent. The Wall Street meltdown of a year ago might have been avoided if interest rates had been kept at sustainable levels in the first place. A year later, the United States is still on the verge of a financial system collapse, and it might not be too late to stay out of trouble by raising interest rates, perhaps over a period of a few months, to 4 percent.