Must-Read: Tim Duy: Why the Fed Can’t and Shouldn’t Raise Interest Rates

Must-Read: Tim Duy: Why the Fed Can’t and Shouldn’t Raise Interest Rates: “The Fed should consider the need for two targets…

…the level of rates and the slope of the yield curve…. For now, the Fed appears committed to just the interest rate tool. And in some ways, that is no surprise. Short-term rates are a comfortable tool for the Fed, whereas playing with the yield curve via the balance sheet is seen as fraught with danger. But with the yield curve flattening as the economy approaches full employment, they may find themselves unable to maintain the appropriate level of financial accommodation via rate policy alone…. The Fed needs to remember that how they got into this policy stance may offer a lesson for how to get out. Policy makers cut rates to zero and then instituted quantitative easing. Now they should consider selling assets before raising rates. Or, at a minimum, utilizing a mixed strategy of rate hikes and asset sales. The objective of meeting the Fed’s mandate in the context of maintaining financial stability may be unattainable using the interest rate tool and associated forward guidance alone. Unfortunately, the Fed does not appear to be debating the policy mix–at least not in public. They remain focused on interest rates, delaying balance sheet policy to a later date. On the current trajectory, however, that later date may never come.