As I do every Friday with my summary of the week’s events with both positives and negatives, here are my pro’s and con’s with current Fed policy and the possibility for more:

Positives:

1) By lowering the cost of capital, cheap money encourages businesses to lever up and invest the proceeds and consumers to borrow and spend to boost the economy.
2) Refinancing existing debt becomes highly attractive.
3) Lifts asset prices if you happen to own them as about 50% of households don’t own any stocks or mutual funds.
4) With a lower discount rate, the present value of future cash flow turns higher.

Negatives:

1) Negative real interest rates is killing savers in order to bailout over indebted borrowers.
2) Pension funds are becoming more and more dangerously underfunded, threatening the retirements of many individuals and the balance sheets of companies and governments.
3) Artificially set interest rates misallocates capital, results in malinvestment, and distorts and manipulates markets.
4) The pricing mechanism/discovery is damaged if the cost of money is fake.
5) Debases the US$ (CPI index, aka cost of living, is less than 1 pt from a record high).
6) Massive monetary inflation is price inflation tinder box.
7) Deeper the Fed digs, the harder it will be to climb out.
8) The wealth effect is fleeting and so is its economic impact.
9) Cost of money doesn’t matter when huge deleveraging needs to take place.
10) Fed engineered easy money creates illusory feel of an economic fix.
11) Cheap money is candy to the Federal Gov’ts love for spending money.

Category: Federal Reserve, Taxes and Policy

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

19 Responses to “Pro’s/Con’s of Fed Policy (with more to come)”

  1. cpd says:

    Excellent list. It’s really criminal that Bernankio and his team of expert economists can’t figure this out. It just reinforces the point that the central bankers really work for the banks. The Fed’s dual mandate is a joke.

  2. warren.buffett says:

    ZIRP(and Fed) bashers are assuming that the free market itself wouldn’t have set the interest rate to near 0. The mood of the economy is hoarding, it doesn’t matter whether the Fed or Free Market sets the interest rates — it’ll be near zero.

  3. Frilton Miedman says:

    No debating any of the above, save to parse this –

    “1) Negative real interest rates is killing savers in order to bailout over indebted borrowers.”

    While many who live in Wall St circles complain about this, I hear nothing from those circles About the reason the consumer is so leveraged.

    Consumer debt over the last 30 years is even worse than government debt, until we hear more about this and some rational debate on why it got this way and how to undo it, I hear no solutions, only whining.

    Santelli, just today, bitching and moaning about the latest attempt to write down mortgage debt, this debt is the direct result of market manipulation as a result of banking, ratings co’s perpetrating fraud, bloating prices and conning consumers into taking out loans based on those prices.

    Now the consumer is stuck with the loan they took out to subsidize con men’s bonus packages, enough already.

  4. DarthBeta says:

    Great list for college kids looking to study monetary and fiscal policy 101 or for the media; not so great for real world investors.

    Absent is the relationship between monetary and fiscal policy; lower rates and higher taxes or higher rates and lower taxes or both moving together.

    No mention of real vs. nominal rates? Or the fact that most investing is done on expectations of future rates, inflation, ect not current

    Most of your list comes from the presepctive of the borrow. Rates (ex libor <s) are set by supply and demand. Having low rates does not = easy money, why would a bank lend you money when they can borrow at zero and invest in overnight paper at plus bps?

    What is stimulative to an economy is low rates, easy credit, high government spending and low taxes.
    The focus on the Fed is so misplaced it is laughable, all they have ever done is make a profit by providing for the US Treasury (the Fed supplied the US Tres war monies for both WW1 and WW2) Tail (Fed) does not wave the Dog (Congresss and by extension US Tres). Fed Chair BB has repeatedly made this point clear. The Fed reacts to what the Treasury wants done. Treasury is told by congress what to do.

    It is a nice list but its narrowness subjucates the discussion on how to grow the economy

  5. 873450 says:

    Are pension funds more and more dangerously underfunded because today’s interest rates are artificially low?

    Or, is it because for two decades Wall Street suckered companies and governments into buying complex, “innovative” debt-financed investment products promising higher, “insurable” returns that enabled them to reduce mandatory contributions to employee pension funds?

    And now that it’s all gone bust, the pension fund deficits get blamed on greedy unions for having members with pensions.

  6. rktbrkr says:

    If you think it’s bad for pension funds just think about Soc Sec which is getting doubled donged with low int on it’s bonds and 2% payroll tax cut.

    Add to that the effect of high unemployment, unemployed forced to draw SocSec early and the mysterious surge in the number qualifying for disability Soc Sec and it becomes a SocSec gang bang

  7. DeDude says:

    Problem is that it is very hard to fight the consequences of deleveraging by lowering the cost of money. The effective tool for the current situation is that government spending and borrowing should pick up to take the brunt of the effects of private sector deleveraging. I think the rule should be that government compensate for between 1/4 and 3/4 of the private sector deleveraging, depending on how high unemployment is and whether it is moving in the right or wrong direction. The ultimate stupidity is to allow people who desperately need and want work to go unemployed, because that is a permanent loss of wealth that will never be recovered. If the Fed really want to print money they should print a nice new $1000 bill for every person in the country. There is an effective and fair way to push the economy forward.

  8. willid3 says:

    well i suspect that is pretty clear why consumer is so over indebted. their incomes have been on a downward slope since the 1970s.
    also suspect that the market would set interest rates as low (if not lower, after all its still demand and supply that sets rates) as what the Fed has,. because there is no demand for credit. business isn’t interested. customers (consumers) aren’t either. so even with all of this ‘easy’ money. there is not much demand for it
    and we can tell this because JPM took a huge bucket of depositor cash to Europe because they thought they could make money there. instead they lost.

    now if the Fed stopped paying interest on reserves would it matter? not sure. banksters would find another place to put the money.

  9. Moopheus says:

    “1) By lowering the cost of capital, cheap money encourages businesses to lever up and invest the proceeds and consumers to borrow and spend to boost the economy.”

    But they probably won’t; businesses want to see demand rise first, consumers still have too much existing debt.

    “3) Artificially set interest rates misallocates capital, results in malinvestment, and distorts and manipulates markets.
    4) The pricing mechanism/discovery is damaged if the cost of money is fake.
    5) Debases the US$ (CPI index, aka cost of living, is less than 1 pt from a record high).
    6) Massive monetary inflation is price inflation tinder box.”

    All of these are just talking points out of the anti-Fed memos. Inflation is low and the dollar index is higher than it’s been in a couple of years, so talking about “debasing the dollar” doesn’t really make a lot of sense. The velocity of money in the economy is at a low point and declining; if anything that suggests a serious deflation threat. The cost of money is fake and artificial? Well, that’s the regime we’ve been operating with for the last 100 years. Today’s action (or lack thereof) isn’t going to change that particularly.

    “11) Cheap money is candy to the Federal Gov’ts love for spending money.”

    Gosh, now that’s not an ideologically loaded statement at all, is it? After all, as we sit here, Congress, knowing that the Fed is “running out of bullets” has been swept up in a fervor of bi-partisan action and is getting together to pass a massive new spending bill to inject some more Keynesian stimulus into the economy. Oh, wait, they’re not?

  10. [...] of the economy and financial markets either positevely or negatively to varying degrees (see here). L. Randall Wray notes in a piece today for EconoMonitor about the darker side of ZIRP, which [...]

  11. mathman says:

    Here’s our outstanding federal policy on climate change bearing fruit.

    http://www.countercurrents.org/spencer010812.htm

    Grain Markets Soar On Worldwide Crop Downgrades

    By Naomi Spencer

    01 August, 2012
    WSWS.org

    “Downgraded harvest outlooks in the US, Russia and Australia sent grain markets soaring upward Monday. As US crops wither under the most severe drought and heat wave in more than half a century, droughts in Canada and the Black Sea growing region, a below average Indian monsoon, and a massive downgrade of the Australian wheat harvest threaten a global food crisis.

    For the eighth consecutive week, the US Department of Agriculture (USDA) on Monday reported a deterioration in the nation’s corn crop.

    As of the week ending July 29, less than one quarter (24 percent) of US corn is considered in “good” or “excellent” condition, down from 77 percent in mid-May. Only 3 percent of the corn crop across 18 states surveyed was rated as “excellent.”

    Soybeans were also once again downgraded, with 29 percent in good or excellent condition and 37 percent in the worst categories. These ratings are the worst since the drought of 1988, which devastated the rural economy and forced thousands of smaller farmers out of business.

    There are no signs that the drought or heat wave will ease in the coming weeks before soybean harvest. Across the southern corn belt, high temperatures will continue to approach 110°F, USDA meteorologist Brad Rippey said Monday.”

  12. wally says:

    Where to begin?
    Positive #1 – yes, that is conventional wisdom. Low interest rates encourage borrowing and leveraging (yet you later mention being leveraged as a negative). There is another effect of low interest rates: it seems to induce a lethargy of investment, opposite what conventional wisdom expects. It takes the pressure off, so to speak and, as Moopheus notes above, slows the velocity of money. It is velocity, not quantity, that makes the economy go round.
    Positive #4 – greater present value to future cash flow? Well… don’t you lower your cap rate. too?
    Negative #11 – isn’t this a positive, not a negative? We need spending now. Whether it comes from government or private pockets makes no difference. Buying a bridge or highway is just as good, and probably better, than buying a new Mercedes.

  13. Frilton Miedman says:

    wally Says:
    August 1st, 2012 at 4:19 pm
    Where to begin?
    “…. It is velocity, not quantity, that makes the economy go round. ”

    Perfect, I find it simultaneously hilarious and tragic that so much focus is on everything but this.

    Tax cuts for theoretical “job creators” & the “investment class”, cuts to entitlements, food programs or healthcare that are staples for those who need them, obsessing over labor unions, but no one talks about velocity or consumption…just further enhancements to the policies that have gotten us here.

    Welcome to the monarchy of whatever random billionaire decides to buy your government.

  14. bmoseley says:

    thanks for #1 Con (harm to savers) it needs to be recognized MORE.

  15. Jim67545 says:

    Ah ha! Velocity. How many times have we heard an “expert” opine that the reason for slow growth is that too much money is going to the government as taxes therefore starving private enterprise of the funds they need to prosper? Therefore we must lower taxes. I guess to those numbskulls this seems logical. My wife has gotten tired of my screaming “what about velocity?” and “do you think the government hoards it somewhere?”at the TV.

  16. Unfortunately, many pundits aren’t listening to the FOMC members themselves. They have been stalwart in expressing their consensus sentiment is that the ball is in Congress court. The FOMC stance is to keep their powder dry in case of Eurozone repercussions.

    So far neither the EZ nor European Union have had a single quarter of contracting GDP. The ECB just lowered rates to prevent same in Q3.

    China’s battle with inflation is complete and growth surged to 7.6% in Q2 from 6.7% in Q1.

    OTOH as Congress plays in campaign mode instead of working in DC, USA GDP has plunged from 4.1% in December to 1.5% in June. And the trajectory continues to be dismal : TRI gauges July GDP was 1.0% and projects worse for Aug & Sept. This is clearly a “made-in-Washington” downturn.

    TRI chart: http://trendlines.ca/free/economics/RecessionIndicatorUSA/USA-TRI.htm

  17. Bernie X says:

    ” 6) Massive monetary inflation…”

    What are you talking about ? USD M3 is up 7% since Jan 2009. Is that “massive” ??

  18. Winston Munn says:

    Before low rates can stimulate an economy, a borrower needs either A) a good job, or B) loose lenders, a bad job, along with the illusion that there is an ever-rising asset class in which he can partake.

    As the chances for a quick repetition of B) is almost nil, it appears we are simply fucked.

  19. howardoark says:

    what does this mean?

    5) Debases the US$ (CPI index, aka cost of living, is less than 1 pt from a record high).

    Here’s the CPI monthly for 2012

    226.665
    227.663
    229.392
    230.085be
    229.085
    228.085
    227.085

    So, he’s right that the CPI is below its all time peak, but how is deflation debasing the dollar (isn’t it the other way around?) And if we are experiencing deflation right now, why did I have to hear about it here? Shouldn’t Bernanke be panicking?