Congress to Set Interest Rates?

Honestly, I thought I had heard just about everything! But today’s news stunned me with the announcement that Senator Pat Toomey, Republican from Pennsylvania, believes the Federal Reserve has lost its credibility. He specifically feels that interest rates in our economy are much too low and the Fed has not done enough to raise the rates.

Evidently, Mr. Toomey feels rates are set by fiat at the Fed. He faults the Federal Reserve for allowing the rates to languish too long at near zero %. Sen. Toomey stated he thinks Congress should set the rates. Apparently Toomey doesn't understand economics and money and banking!

There are a few problems with his suggestion.  First, Congress can’t make budgets so why should anyone trust them to set interest rates for the market place?  Second, interest rates are a function of supply and demand of available cash, not a function of one person or a committee to decide the rate and so declare it. Third, the US Constitution provides for separation of powers in the federal government. The Executive Branch embraces the Federal Reserve System. The Federal Reserve System is governed by a very arcane, complicated set of rules and regulations not made entirely by Congress. Fourth, Mr. Toomey demonstrates his ignorance of the subject matter with every breath.

For instance, supply and demand of cash in the American economy is not tight. Cash abounds. Unused balances in savings, checking and short term accounts are enormous. Perhaps as high as $7 trillion. That’s Trillion with a T, Sen. Toomey. Because cash  liquidity is so high, interest rates are low. Tight liquidity would dictate higher interest rates – you know, use of the dollars chasing too few dollars will push interest rates higher. The opposite is true – too little use of the money means low interest rates. And lots of idle cash. 

Interest rates also are a function of risk. If a person wants to borrow funds for a project, the interest rate will follow risk. High risk means high interest rates if the loan is even granted. But if the risk is low – let us say collateral is available to guarantee repayment of the loan should the project fail, then the interest rate would be much lower. If the collateral will require a lot of time to convert the asset value to cash to pay off the loan, then the interest rate will be higher. If a borrower has a poor track record on repaying loans in a timely manner, the interest rate will be much higher; if the credit of the borrow is too poor, the loan will not be granted.

Risk is an important indicator of loss potential. Thus interest rates will be higher with more risk. Simple concept; difficult to measure at times, so calculating a specific interest rate is tedious and complex. That's why market forces are always part of the calculation.

Congress has a difficult time discussing simple topics and making decisions on them. Policy decisions are even more complex for Congress to handle. The whole idea that Congress could even approach setting interest rates is down right laughable.

More disturbing is the fact that a Senator came up with this poor idea. It demonstrates his total lack of understanding. His sheer ignorance is on full display.

My bet is he is not alone.

This is just another example of why Americans have so little respect for Congress and its poor performance. They have earned such ratings from the public. Shame on you, Senator Toomey!

July 17, 2015