Monetary policy making — the management of interest rates to fulfill the objectives of price stability, maximum employment, and economic growth — is a lot like steering a large ship. Actions taken to change course lag. The ship doesn’t turn the moment the rudder moves, it takes time for the action to actually translate into movement. So in steering the monetary policy ship, policymakers need to make decisions well in advance of when they expect to see the impact of those decisions in the economy. For example, if the Fed wants to curb the aggressive financial gamesmanship rampant in the current low-rate environment, it will need to act months in advance of when it wants to see a change in market behavior.
In a speech delivered at University of Southern California, famous protestor of monetary policy accommodation Richard Fischer, chief of Federal Reserve Bank of Dallas, spoke about the risks emanating from maintaining a loose monetary policy — that is, of not turning the ship after maintaining the same heading for so long.
“I believe we are at risk of doing what the Fed has too often done: overstaying our welcome by staying too loose too long,” Fischer said. “We did a good job in staving off the deflationary and depression risks that were present in the aftermath of the 2007 – 09 financial crisis. We now risk falling into the trap of fighting the last war rather than the present challenge. The economy is reaching our desired destination faster than we imagined.”
One of the biggest risks, Fischer pointed out, are yield hunters. These are investors and money managers who are out on the prowl, looking to maximize returns in a challenging investing environment. “When money is dirt cheap and ubiquitous, it is in the nature of financial operators to reach for yield,” Fischer said.