The Fed's Hubris Endangers Future Prosperity

Yesterday Janet Yellen vice chairwoman of the Federal Reserve spoke about the need to maintain a near zero interest rate policy until 2015. Her comments belie the fact that the economy has not responded to years of a low interest rate environment with a massive increase in spending as she and other Fed officials probably wished. There has not been a great rush to buy cars or technology or houses or anything normally associated with borrowing. The only thing which has been affected by the low interest rates are the amount of money devoted to speculation. The scenario for speculators is simple: borrow money at 20 basis points and then take on speculative risk earning them 500 to 700 basis points. The real side of the economy has responded to rising exports driven by the low value of the dollar partly caused by the low interest rates. Many Americans are looking for a job and this policy is not helping. Yet the Federal Reserve persists in believing in its policies as opposed to a policy of lower tax rates and other incentives proven to create new companies and new jobs during a crisis or a liquidiy trap.

The unintended consequence of their hubris will probably show up in three or four years in a massive burst of inflation. Not unlike the European Central Bank which is lending money to private banks so that they can buy "bad" Eurropean government debt, our Federal Reserve seems to be overly focused on near-term problems at the expense of longer-term issues. The low interest rates are likely to create another wave of bankruptcies down the road amongst companies obtaining financing in the junk bond market despite their lack of credit standing. The situation is not dissimilar to the Fed's encouragement of the housing bubble a decade ago or the Internet stock bubble. Economies don't do well going from boom to bust. That is the problem with unintended consequences: they don't show up immediately and so people/businesses/government make bad choices. This may be another one.

There is more on similar topics at my blog harlanplatt.com.