Why the Fed initially plans fail?

Committee members of the Federal Open Market Federal Reserve (FOMC) did not really like to be at the lower bound of zero (zero lower bound, ZLB). Since December 2008, the Federal Reserve to keep interest rates on federal credit funds in the range of 0% to 0.25%: the lowest possible level (zero return on cash means that the central bank can not actually use a negative interest rate).

Since then, the definition of policy turned into a real monetary chaos. Justified or not, but the members of the Fed are considering unconventional steps (such as the purchase of assets or pledge to keep interest rates low for an extended period of time), which are more dangerous than the traditional policy of determining the interest rates.

FOMC members are afraid that both can encourage irresponsible borrowing and distort the situation in the market, says the British magazine The Economist.

Some economists believe that, despite the threat of financial instability, the central bank can not do their job, when the basic interest rate is zero.

Since December 2008, the Fed has achieved two main objectives: the maximum growth of employment and stable prices. The unemployment rate is still far from the desired level of the Fed and inflation the past six years is below or well below 2%.

All this is a serious problem for the American economy and the Fed. It is possible that this is the most pressing problems that the Fed has ever faced.

Then why the Fed tends to return in the future to the lower boundary of zero, hoping, apparently, first to leave the ZLB?

According to the latest economic forecast FOMC, the average federal funds rate will be 3.75% for a long period of time. Meanwhile, according to the so-called scatter chart, almost every member of the FOMC makes it clear that the markets should ignore it. But markets are hoping that if Janet Yellen will retain control of the Fed, that by 2017, the rate will reach 4.25%.

But it’s not happy. The federal funds rate rose to 5.25% before the Great Depression, and then collapsed to the lower bound of zero. The recession in 2001 was not very strong, but the Fed, however, lowered the interest rate from 6.5% to 1%, keeping it at this level for a long time. There are many opinions about the size of “cushion” that is needed between the federal funds rate and the ZLB, but most economists believe that the four percent “definitely not enough.”

Why bet for a long time will be so low? Firstly, the real interest rate, adjusted for inflation, that balances supply and demand in the economy, lower than it was before. This is due to expected long-term growth retardation or structural factors, which in turn leads to an excessive increase in savings.

But for any real interest nominal rate (which sets the Fed) can be arbitrarily increased by a simple change of long-term inflation, which the central bank sets for himself as a target.

Everyone knows that the central bank may choose a rate of inflation, which considers it necessary for the economy, and in doing so, may deliberately increase the long-term interest rate on federal credit facilities, so the Fed has no reason to be too low interest rate.

Of course, the central bank is difficult to control inflation when it is at the lower bound of zero. But in order to keep control of inflation, perhaps, to begin with the Central Bank would have to carry out their direct responsibilities, and strengthen its authority – then the Fed would be able to get away from the ZLB (for example, by delaying the easing of monetary regulation before the strengthened growth and inflation will rise to the desired level).

But if we go back to the Fed’s economic forecast, we see that the FOMC plans to raise rates in the next three years, despite the fact that inflation was expected to continue throughout this period is less than 2%.

Why did they go for it? There is one assumption: they are afraid that if the raise the inflation target, it will cast doubt on their professionalism and credibility.