The Federal Reserve's focus on keeping nominal interest rates near zero is potentially dangerous long-term since low rates hurt retired savers, Federal Reserve Bank of St. Louis CEO James Bullard said Monday.
Bullard said in a speech that concerns over the nation's large output gap is forcing the philosophy that 'keeping inflation at bay' is a priority. This, in turn, forces the idea that nominal interest rates should remain near zero, Bullard suggested.
"If we continue using this interpretation of events, it may be very difficult for the U.S. to ever move off of the zero lower bound on nominal interest rates," Bullard said Monday when speaking to the Union League Club of Chicago in Illinois. "This could be a looming disaster for the United States. I want to now turn to argue that the large output gap view may be conceptually inappropriate in the current situation. We may do better to replace it with the notion of a permanent, one-time shock to wealth."
Bullard said a near-zero interest rate policy for the next few years could distort decision making in the economy, hurting overall economic growth, while creating a low inflation target that makes it difficult to edge up rates in the future.
He says this is especially true with low rates hurting savers, who are generally older Americans with fixed-income and assets. Meanwhile, young Americans are struggling with job prospects, making it less likely they will be able to stimulate economic activity by taking advantage of low interest rates.
"Consequently, the consumption of the older generations may be damaged by the low real interest rates without any countervailing increase in consumption by other households in the economy. In this sense, the policy could be counterproductive," Bullard said.
In his speech, Bullard said taking a different view of the housing crash and economy would put the realities of today's economy into perspective. Rather than expecting the recovery to end with exponential growth, he says, the 2008 crisis should be viewed as a one-time shock to wealth as home values plummeted 30% after the year 2006.
"Since housing prices are not expected to rebound to the previous peak anytime soon, that wealth is simply gone for now," Bullard said. "This has lowered consumption and output, and lower levels of production have caused a significant disruption in U.S. labor markets."
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