Is Fed Policy Backfiring?
June 30, 2010
As expected, the Federal Reserve announced last week that would leave its key interest rate unchanged, at a level just above zero. What was unexpected was a pledge to continue this low rate policy for "an extended period of time."
The context behind that pledge is the worsening economic picture -- a double-dip recession now seems a real threat. However, it is possible that the Fed's pledge, and even the low-interest rate approach in general, might be backfire and make the economic situation even worse.
In previous blogs and articles, MoneyRates.com has examined reasons why the Fed's low interest policy hasn't been working -- it amounts to "pushing on a string," or applying stimulus where there is no underlying demand. To say that the policy is actually counter-productive goes a step farther, but consider the following two points:
- Low interest rate policies reward borrowers and punish savers. However, there is little demand for borrowing, and little inclination on the part of banks to make loans. Meanwhile low interest rate policies keep CD rates, savings account rates, and money market rates down. This effectively takes money out of the pockets of the people who are in a position to spend -- people with savings. That missing money could be helping the economy.
- The pledge to keep interest rates low creates a lack of urgency. If you are trying to stimulate the economy, you want people to take action now. The fact that interest rates are at record low levels should help do that, unless you make a pledge that allows people to be complacent about the fact that those low interest rates will still be available in a few months. With its words last week, the Fed may well have created that complacency.
