Exiting from Low Interest Rates to Normality: An Historical Perspective

Sunday, November 30, 2014

Working Group on Economic Policy: WP14110

Abstract:

This paper examines the Federal Reserve’s recent policy of quantitative easing by looking back at the experience of the 1930s and 1940s when the Fed, under Treasury control, kept interest rates at levels comparable to today and its balance sheet increased similarly. The paper also presents macroeconomic evidence based on the labor market, the growth of the money supply, and the behavior of real GDP and the unemployment rate in addition to a comparison of the Federal funds rate with the Taylor Rule rate and the shadow funds rate. Because of issues connected to its large balance sheet, the Fed may use tools other than the federal funds rate to tighten monetary policy. Returning to a higher (more normal) rate environment will remove some of the distortions that have accompanied the long period of abnormally low interest rates. But rising rates will also present problems for public finance and for the distribution of income that all but guarantees political rancor in the future.

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