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Would Higher Interest Rates Boost US Growth?

The Federal Reserve cannot stabilize the economy, create jobs, and avert problems stemming from abnormally low interest rates simply by raising the federal funds rate. Rather, businesses must first create savings vehicles and make investments, to which the Fed can then respond by allowing interest rates to rise.

BERKELEY – Blackstone CEO Tony James recently published a column in the Financial Times titled “To revive America’s economy, raise interest rates.” This is a very bad idea.

Let us imagine that we have been transported to a parallel universe, one where the US Federal Reserve has not held interest rates at or near zero. Instead, this Fed has gradually raised interest rates for the past six years, and the federal funds rate is now 400 basis points higher than it currently is. Before looking at what this alternate-universe economy would look like, let us review what has happened in the real world.

In the fourth quarter of 2015, households, businesses, and foreign investors saved $940 billion in the United States. Of that amount, $185 billion was invested in newly issued government bonds, and the other $755 billion flowed into interest- and dividend-paying savings vehicles such as loans, corporate bonds, and new equity issues, which in turn added to the US private sector’s productive-capital stock.