When the Federal Reserve finally begins its effort to raise interest rates, it may have trouble with the logistics, says
former Wall Street Journal columnist George Melloan.
The market consensus is that the Fed will raise rates in the second or third quarter of next year. The central bank has kept its federal funds rate target at a record low of zero to 0.25 percent since December 2008.
"A crucial part of today's when-will-it-happen guessing game is exactly how would the Fed go about draining liquidity if a burst of inflation urgently presented that necessity," Melloan writes in The Journal. "The traditional mechanism used by the Fed no longer looks to be serviceable."
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That's the fed funds market. But banks possess so much excess reserves — $2.9 trillion — that "for all practical purposes, the federal funds market no longer exists," he says.
Macroprudential policy — influencing banks through regulatory policy — has become the latest buzzword for how the Fed could manage a rate hike.
"If the Fed can't control interest rates, the dollar supply and inflation by any other means, maybe it hopes to do it by fiat," Melloan writes. "Well, the dollar is a fiat currency so perhaps its management by fiat was inevitable."
Meanwhile, Harvard economist Martin Feldstein has argued for at least two years that the Fed's easing program is ineffective.
Fed policy is creating too much risk in the financial system, he tells
CNBC. "Very low interest rates are driving lenders into taking risks, low-quality loans [and] investors into buying junk bonds with low spreads."
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