Keeping rates artificially low leads to more economic distortion.
Ramesh writes on the Corner:
The U.S. has a government-issued currency and a central bank. Maybe we shouldn’t have these institutions, but they are likely to be around for the duration. Sometimes they perform better, sometimes worse. My view — brace yourself for this — is that as long as we have them, it would be best if they worked as well as possible: keeping supply in equilibrium with demand, neither generating nor amplifying boom-bust cycles, avoiding the creation of uncertainty that impedes individuals and businesses from making and acting on their plans.
I agree. So long as the central bank has discretion over monetary policy, exercising its power in a steadier, more constrained manner would not qualify as interventionism or central planning. The Federal Reserve has to steer the money supply in one direction or another. Keeping policy the same is as much of a choice as changing it.
This principle extends to the Fed’s principal tool for setting monetary policy: benchmark interest rates. Many people assume that when the Fed raises or lowers rates, it is cutting against the free market that determines rates in the first place. But the Federal Reserve has been setting interest rates — at least on the funds that banks lend to one another — since its creation in 1913. Today, it keeps these rates within a narrow band using both a ceiling and a floor. The Fed currently lends to banks at 4 percent, so no bank will borrow at a higher rate, and it pays them 3.9 percent interest on dormant reserves, so no bank will lend at a higher rate. The central bank is always setting these rates.
When I argue for raising interest rates, I don’t do so because I think rates should be higher than where market forces would otherwise have them. I do so because I believe that the Fed has already set rates too low, and that this has caused the money supply to grow faster than appropriate (as most new money is created by bank lending, and artificially low interest rates stimulate this credit creation).
In my view, this rate suppression is the true central planning by monetary authorities. It’s difficult to believe that free markets would have kept borrowing costs so low for so long without the Fed’s dual price controls. An upward correction, therefore, would result in less distortion than the status quo.