While the financial markets wait for higher rates orchestrated by the Fed, officials of the central bank are looking toward fiscal policy as a major catalyst for their rate hikes.
Vice Chair Stanley Fischer, speaking before the Economic Club of New York on Monday, said that according to the Fed’s FRB/US model, an increase in government spending equivalent to 1% of GDP would raise the equilibrium interest rate 50 basis points, or 0.50%, while a 1% cut in taxes would raise it by 40 basis points and a 1% increase in corporate investment would add just 30 basis points.
He noted that the model does not include much detail about taxes and government spending but rather measures the effects of “very broad changes in income taxes and government spending.”
Fischer defined the equilibrium rate as the Fed funds rate that will prevail in the longer run, once cyclical and other transitory factors have played out; in other words, a Fed Funds rate that neither stimulates nor stifles economic growth.
“While there is disagreement about what the most effective policies would be, some combination of more encouragement for private investment, improved public infrastructure, better education, and more effective regulation is likely to promote faster growth of productivity and living standards,” said Fischer.
“Central banks are finally realizing that their attempts to spur economic growth with low interest rates, then QE and most recently, negative rates, haven’t worked,” wrote Gary Shilling, founder and president of A. Gary Shilling & Co., in his latest market outlook. “In tacit admission of the impotency of money policy, central bankers are intensifying their calls for fiscal stimuli.