What Would Happen if the Fed Decided to Raise Interest Rates?

BY busadmin  January 26, 2009 at 3:06 PM EST

Federal Reserve Chairman Ben Bernanke; AP photo

Question/Comment: A stupid question, perhaps, but here goes. Okay, lowering the overnight rate to 0.25 percent doesn’t seem to have worked very well. What would happen if the Fed decided to RAISE the rate by a percentage point or two? Would that make banks think they could earn a little money by lending again?

Paul Solman: The motto of this page — and my career— is that there ARE no stupid questions (as I explained at some length in a 1992 Columbia Journalism Review article, the Internet is just plain amazing, isn’t it? I just Googled “no stupid questions” and “Solman” and voila!)

As to YOUR non-stupid question: First, how do we know the Fed’s lowering hasn’t worked very well? We can never know the counterfactual: What would have happened had the Fed NOT lowered? The purpose was to keep world credit markets from completely freezing. Or as one former Fed economist, Steve Cecchetti, now with Basle’s Bank of International Settlements, put it in a piece of ours: “That’s what was at risk here . . . that we were going to get up one morning and that the financial system would simply not be operating any longer. You would go to the grocery store, you would run your debit card through at the checkout, and the payment wouldn’t go through because your bank wouldn’t be operating.”

Second, and more to the point: If the Fed RAISED the interest rate, businesses and consumers would be even less inclined to borrow and spend than they already are. The reason Obama is proposing a big “stimulus” package is to STIMULATE – by spending. The last thing we want to do at this point, then, is DE-stimulate. But that’s the effect higher interest rates would have.