Fed blowing its chance to raise rates: Economist

How the Fed rate hike affects the stock market

Maintaining zero interest rates for so long is creating a scenario in which containing risks "becomes virtually impossible," according to an analysis from a former Fed official.

A "muddled mandate" has the Fed too focused on unemployment at the expense of price stability, wrote Athanasios Orphanides, a global economics professor at the Massachusetts Institute of Technology's Sloan School of Management.

Former Fed boards knew enough to begin raising rates after long periods of accommodation well before the economy hit the full, or "natural," unemployment rate, said Orphanides, a respected former senior Fed advisor and member of both the European Central Bank and Central Bank of Cyprus. The paper outlining his views appeared on the St. Louis Fed website and is based on a June speech he gave to that branch of the U.S. central bank.

In the analysis, he paints a grim scenario should the Fed not choose to start hiking rates soon, calling the current scenario "the case of the missing liftoff." The unemployment rate, currently at 5.1 percent, equals the 5.5 percent rate that the Congressional Budget Office considered full employment back in February, signaling the Federal Open Market Committee is well behind when previous Feds chose to begin raising rates, he said.

"If policymakers wish to ensure full employment and price stability over time, they cannot afford to permit immense policy accommodation in the system once full employment is reached," Orphanides wrote. "If they did, it would not be feasible to withdraw that accommodation on time without either generating inflation or tightening so abruptly it could cause a recession. For this reason, policy normalization ought to commence long before reasonable estimates suggest full employment has been restored."