Monday, September 5, 2011

The Fed's Gun is Empty

According to Ben Bernanke, the Fed stands ready with additional potential undisclosed policy responses if the economy continues to struggle.  My question is to what effect?

As noted several times, the Fed's powers are limited to those of monetary impact; essentially it controls the money supply, historically by raising and lowering short-term interest rates that it charges banks, thereby encouraging or discouraging them from lending and speeding or slowing the economy as the case may be, and more recently by "Quantitative Easing", which is simply printing money.  With rates now at nearly 0% the Fed’s lending power is essentially spent; Quantitative Easing has produced the specter of inflation, nothing else. 

Under normal circumstances, rates this low would have already spurred the economy. But instead of giving the system time to reset and take advantage of the low rates, our President decided that the Great Recession was “too good to waste” and passed Obamacare, the most onerous piece of legislation in history, more than cancelling out the positive interest rate effect. 

That being the case, can anyone truly be surprised that the economy is still bumbling along.  I'm surprised it's not worse.  What's really amazing is that the President does seem to understand the basic reason why since his coming so-called "jobs speech" is rumored to contain a number of reductions, albeit small ones, to business taxes and possibly some regulatory easing.  Duh!  I guess he's not totally clueless regarding the impact of Obamacare!

But the point of this post is not, once again, that the President made a huge mistake by passing Obamacare. It's that counting on the Federal Reserve to do anything else beyond what it's already done is like believing in the Wizard of Oz.

When Lehman Brothers failed, the Fed arguably saved the world from a catastrophic meltdown by providing liquidity and backstopping the survival of American banks.  That's what it didn't do in 1929 and no doubt pushed the country into the Depression.   Beyond providing liquidity, however, which is really just a fancy term for printing money (or making sure everyone knows it will), the Fed can't do anything!  Everything it does--or has ever tried to do--is just some variant on that power. So when the Fed says they still have options, all they mean is that they have other ways of printing money, which would really only be useful if the system threatens to lock up again—not for creating jobs or growing the economy.  It has no secret job or growth creating powers.  And I'm not sure that either the President or the Congress realizes that. 

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