Staff writer Nell Henderson discusses whether the Federal Reserve Board has fallen behind the inflation curve and should have raised rates already ["Fed Stays Put on Rates," Business, May 5]. Chairman Alan Greenspan probably is correct that incipient inflation is not a danger now. There is another reason, however, that the Fed should start raising rates when it can do so without slowing the economy too much: to be prepared for a precipitous drop in asset prices. The United States now borrows $500 billion a year from abroad to finance its imports. There is always a danger that foreigners will not provide the extra funds needed or will even withdraw funds that they have already invested in U.S. assets. This could roil stock and bond markets.
In this case, the country could be in bad shape if the Fed could not respond by lowering interest rates. With the Fed's interest rate target at 1 percent, it risks being unable to lower interest rates sufficiently to contain the fallout from falling asset prices.
The best time to reload your gun is when you don't need to use it. Similarly, the best time to gradually raise rates may be when the economy is growing well and there is no financial crisis on the horizon.