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Posted 05.03.2010

Beyond zero: the future of interest rates

Kansas City Fed chief advocates easing them higher

By Mike Cote

While the Federal Reserve has continued to keep rates near zero, the president of its Kansas City bank says the Fed will have to begin edging rates back up so the economy can achieve long-term health and stability.

While Thomas Hoenig said he would never advocate a "sharp jump of policy rates," the long-time Fed official told a group gathered at the Phipps Tennis Pavilion in Denver that the Fed will need to "normalize" rates so it can balance the economy, one that is driven by the supply and demand of the markets.

"If we don't bring it back in balance ... our ability to have long-term, sustainable growth and wealth will be compromised," said Hoenig, noting that low interest rates consumers are earning on savings accounts are effectively subsidizing the economy.

Hoenig was dubbed a "rebel with a cause" by the Wall Street Journal last week for repeatedly objecting to the Central Bank's decision to keep rates low for an extended period of time. He has advocated a modest tightening, shifting rates toward 1 percent.

Hoenig, who took office in 1991, said the Fed was initially correct in keeping rates near zero but after three quarters of positive growth, it's time to move forward: "It was (correct) when we did it, but we have to think about tomorrow."

Addressing students attending the event as part of Money Smart Colorado week, he said consumers have the responsibility not only to manage their own finances but to understand world markets.

"Unless you take the time to understand the economy itself, you will be unable to make the right choices for the nation," he said, alluding to the nation's $1.5 trillion deficit, which he said will affect interest rates and the distribution of wealth for decades to come.

Hoenig began his talk with the most micro of economies: individual personal finances. All the laws in the world won't save you from yourself, he advised students seated among finance educators and volunteers. But he could have easily been talking about government officials, bankers and business people.

The weeklong financial literacy effort this year coincided with Congress wrestling over financial reform. Hoenig said he was hopeful that Congress will enact legislation that better protects consumers, including tighter rules involving credit card disclosures.

"That will do you absolutely no good unless you take the time to educate yourself," he said, alluding to the fine print that trips up many a consumer. "That's the part that saves you - yourself."

During a question and answer session, Hoenig said Greece's economic woes likely won't shake the U.S. economy, but the country's crisis offers a sound warning to the U.S. Greece had it credit rating downgraded to "junk" status last week and is on the brink of insolvency.

"What I want for the United States more than anything is that we don't find ourselves paying that price a generation from now," he said.

Mike Cote is the editor of ColoradoBiz. E-mail him at mcote@cobizmag.com.

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