While the financial markets wait for higher rates orchestratedby the Fed, officials of the central bank are looking toward fiscalpolicy as a major catalyst for their rate hikes.

Vice Chair Stanley Fischer, speaking before the Economic Club ofNew York on Monday, said that according to the Fed's FRB/US model,an increase in government spending equivalent to 1% of GDP wouldraise the equilibrium interest rate 50 basis points, or 0.50%,while a 1% cut in taxes would raise it by 40 basis points and a 1%increase in corporate investment would add just 30 basispoints.

He noted that the model does not include much detail about taxesand government spending but rather measures the effects of “verybroad changes in income taxes and government spending.”

Fischer defined the equilibrium rate as the Fed funds rate thatwill prevail in the longer run, once cyclical and other transitoryfactors have played out—in other words, a Fed funds rate thatneither stimulates nor stifles economic growth.

“While there isdisagreement about what the most effective policies would be, somecombination of more encouragement for private investment, improvedpublic infrastructure, better education, and more effectiveregulation is likely to promote faster growth of productivity andliving standards,” said Fischer.

“Central banks are finally realizing that their attempts to spureconomic growth—with low interest rates, then QE, and most recentlynegative rates—haven't worked,” wrote Gary Shilling, founder andpresident of A. Gary Shilling & Co., in his latest marketoutlook. “In tacit admission of the impotency of money policy,central bankers are intensifying their calls for fiscalstimuli.

“Last March, ECB president Draghi told the European parliamentthat ECB action was “not enough for delivering real and substantialgrowth in the long run [and] … other policies should complement[central bank] action,” wrote Shilling, adding that Fed Chair JanetYellen recently also noted the case for “investment-oriented fiscalpolicies.”

Central bankers like Yellen and Fischer, are not happy with lowrates but also not quite ready to abandon them.

“There are at least three reasons why we should be concernedabout such low interest rates,” said Fischer. “First, and mostworrying, is the possibility that low long-term interest rates area signal that the economy's long-run growth prospects are dim … Asecond concern is that low interest rates make the economy morevulnerable to adverse shocks that can put it in a recession. … Andthe third concern is that low interest rates may also threatenfinancial stability as some investors reach for yield andcompressed net interest margins make it harder for some financialinstitutions to build up capital buffers.”

Despite these concerns, Fischer noted that the Fed has keptrates very low because of its need “to maintain aggregate demand atlevels” that support the Fed's dual mandate of maximum employmentand price stability.

While higher interest rates would provide higher yields oninvestors' bond portfolios, they could also increase the federaldeficit, which has already begun to grow after years of declining.The White House on Friday announced that the six-year decline inthe annual federal budget deficit has ended. The deficit for fiscal2016, ended September 30, was $587 billion equivalent to 3.2% ofGDP, up from $438 billion, or 2.5% of GDP, for fiscal 2015.