It's time to end the party of easy money

March 2, 2011: 3:27 PM ET

Kansas City Federal Reserve Bank President Thomas Hoenig has a message for Ben Bernanke, and he's not afraid to say it over and over: Raise rates.

punch

Once you have a sip, you just can't stop.

At a party where it feels as though virtually nobody is having much fun, how soon is too soon to take away the punch bowl? When the spiked goodness sets everyone in easy laughter? Or even sooner than that?

If Kansas City Federal Reserve Bank President Thomas Hoening had it his way, he'd break up the party before most people even knew they were having a good time.

"I really want to take away the punch bowl before the room gets drunk because I think this punch bowl is a little bit spiked," Hoenig said Tuesday morning at the Council of Foreign Relations in New York City.

Needless to say, the outgoing Fed president was referring to easy cash in his repeated dissent against the Fed's ultra-low interest rate policy. Hoenig's remarks came the same day Federal Reserve Chairman Ben Bernanke told lawmakers on Capitol Hill otherwise. Because there's little inflation risk and slow job growth, Bernanke believes, the central bank should continue its $600 billion bond-buying plan and keep interest rates near zero for now.

If Hoenig were playing chaperone, then Bernanke is playing party planner. For months, the two have been at uncomfortable odds over the country's monetary policy. Hoenig, who has been making a series of media rounds as he prepares to retire from his job in October, says officials should start prepping the market to lift interest rates to 1%. He couldn't give an exact timeline for these actions, but said he'd like to see the increase by this summer. Indeed, the hikes, he adds, would happen little by little so that markets would ease into the new costs of borrowing.

Hoenig might be considered a party pooper, but that's not necessarily such a bad thing. The partying among speculators and the financial markets might eventually come at the expense to the overall economy. After all, as we saw only a few years ago, record low rates led to easy cash and asset bubbles -- namely, the housing bubble that went bust.

The closest thing we have to a bubble today seems to be building in the commodities market, where prices for coal, copper, oil and other resources have been surging. Keeping interest rates low might put markets at ease for now, but appeasing the performance of the stock market is not the job of the Fed.

And what will Bernanke's policy prescription do to the commodities market over time? When might commodities go bust, just as the housing market did under a policy of easy money? And what could be the consequences?

Hoenig clearly wants to avoid such a scenario by raising rates, but it's not clear how much those higher rates might slow the recovery. Home prices -- down 26% since their peak in June 2006 -- are expected to fall further and unemployment still stands above 9%.

The reality is that even if rates rise very slowly as Hoenig suggests, the economy will suffer in the near-term. But looking ahead, a little more short-term pain might be worth it if it avoids a bigger economic shock in the long run.

Perhaps that punch bowl should be filled instead with the bitter medicine the economy needs.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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