The Fed's Folly: Not Normalizing Rates Quickly After the Great Recession

19 Pages Posted: 10 Mar 2016

See all articles by William J. Dodwell

William J. Dodwell

Consultant to Financial Institutions

Date Written: March 1, 2016


For over seven years the Federal Reserve Bank has failed to foster a normal economic recovery in the aftermath of the 2008 financial crisis and Great Recession. By adhering to a zero interest-rate policy, as well as quantitative easing involving the infusion of credit through the purchase of trillions of dollars of government bonds and agency securities, economic performance has fallen far short of historical standards. A long-awaited 25 basis point hike in the federal funds rate in December 2015 is feckless. Chronic near-zero interest rates have forced a massive migration of capital to overvalued financial assets from traditional bank loans, deposits and money market instruments that traditionally fund the real economy. In addition, those rates have rendered bank net interest margins unprofitable resulting in restricted lending, mostly to the most credit-worthy borrowers at the expense of small businesses that create most jobs. Rock bottom rates aimed at stimulating growth through borrowing are not productive if they do not also motivate broad lending throughout the economy.

This paper advocates a relatively rapid normalization of interest rates to restore equilibrium in the credit markets through a steady series of rate hikes. The action would redirect capital away from inflated stocks and bonds back to the production and consumption of goods and services that grow the economy. The particular fed fund rate that supports the movement of enough capital to achieve this may be about 4%., last registered in 2007. Heresy to traditionalists, few economists and analysts have called for such a solution out of fear of upsetting the financial markets and triggering a recession. Even the acclaimed “Taylor rule” that has guided monetary policy for more than 20 years understates the rate requirement under current anomalous monetary conditions. The consensus view does not consider that raising rates from near-zero would not have the adverse impact as raising them from historically normal levels might.

Bold action is required to finally deflate the financial economy and reflate the real economy. In the process, the Fed has to resist short-term market disruptions and less than optimal economic data that heretofore have deterred rate hikes. And monetary ineffectiveness must not be excused on the ground of a “new normal” born of restrictive post-crisis financial regulation and ever-growing big government. Although impediments to growth, normalized interest rates can overcome them. In the early 1980s Fed Chairman Paul Volcker, in different economic circumstances, displayed the courage to take radical corrective action. His policy of sky-high interest rates to wring out hyperinflation initially precipitated a sharp recession but subsequently ushered in nearly uninterrupted expansion for almost 20 years.

Once and for all the Fed should realize it has found itself in a hole from years of ineffectual policy. It’s time to stop digging. Sadly, of late the Fed is considering the opposite in flirting with negative interest rates that mimes the failure of other central banks. Counterintuitive as it may seem, raising interest rates to pre-crisis levels, coupled with fiscal and regulatory reform, would provide the stimulus that has been missing for too long.

Keywords: normalized interest rates, zero interest-rate policy, Paul Volcker's precedent, deflate financial economy, reflate real economy

Suggested Citation

Dodwell, William J., The Fed's Folly: Not Normalizing Rates Quickly After the Great Recession (March 1, 2016). Available at SSRN: or

William J. Dodwell (Contact Author)

Consultant to Financial Institutions ( email )

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