The stock market just blew up the last argument for the Fed to raise interest rates

Since the Federal Reserve dropped its benchmark interest rate target down to near zero in the fall of 2008, a chorus of critics has deployed a shifting variety of arguments for raising the rate immediately. Back in 2009 and 2010, it was looming inflation. When that failed to materialize — when inflation actually remained at historic lows — they moved on to a projection that the recovery was heading toward escape velocity. With rates so low for so long, catch-up growth was just around the corner (remember "green shoots?"), and therefore the Fed must raise rates to stay ahead of the curve.

While the economy is stronger now than it was in 2011, economic and job growth have consistently been weak at best. So the critics have settled on another argument: the risk of financial instability. In this view, low interest rates will cause people to "reach for yield" — i.e. pour money into high-yielding assets — leading to a bubble in risky assets and another financial crisis.

This theory has always had a number of gigantic holes. However, it has completely disintegrated over the last few days — particularly after Monday's hair-raising stock market opening, when the Dow Jones average fell by 1,000 points before making a comeback. If the market is already this unsettled, clearly there is no danger of low rates inducing excessive euphoria among the investor class.

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Now the only question is whether Federal Reserve Chair Janet Yellen will abandon her plan to raise rates in the next month or so.

Since the financial crisis, the Fed has distinguished itself mainly by being not a grotesque trainwreck of an institution, unlike most other major central banks. Sweden began raising its interest rates in 2010, followed by the European Central Bank in 2011. The Swedish move was eventually reversed when the country slid into outright deflation, while the ECB changed course after that move helped create Great Depression conditions in several eurozone states.

The Fed has not done nearly enough, but has avoided doing outright harm, conducting several rounds of unconventional monetary stimulus as the economy repeatedly failed to recover properly.

However, the Fed has also been very obviously itching to get rates up. After winding down its unconventional efforts earlier this year, it has been signaling a hike in rates next month for quite some time. That's despite the fact that full employment has very clearly not been reached, and that the Fed has been undershooting its price target for the past three consecutive years — indeed, inflation has been trending down of late. As a fig leaf justification for raising rates, all that was left was the specter of financial instability. As Larry Summers argues in a great piece, that debate is now over:

In other words, with Europe still mired in catastrophe and Asia suffering serious financial chaos, it's easy to imagine that a Fed rate hike could even spark another recession. More to the point, there was no justification for a hike even before all this chaos. As Paul Krugman writes, since it is impossible to know how much slack is left in the economy, best to hold off on any rate hikes until inflation definitely starts to rise. Once that happens, you can be sure that the structural job creation capacity of the economy is about full, and raise rates without fear of preventing the creation of a great many jobs. The theoretical potential of financial unrest was always nothing compared to the reality of millions of people out of work.

Will any of this sink in over at the Federal Reserve? Yellen is by all accounts an extremely sharp economist. But it sometimes seems like someone has been spiking the water at the Fed with datura.

However, if anything can get the attention of policy elites, it's a market crash. Keep your fingers crossed.