So the Fed is slashing interest rates to try and "stimulate" our way out of this recession, and it's not completely impossible that we'll see a Fed Funds Rate of zero percent. Then comes the news that the incoming administration wants to have the Treasury Department throw its financial support behind Fannie and Freddie, with the stated goal of lowering 30-year mortgage rates to an amazing 4.5%. Now the EU and the Bank of England have slashed their rates as well, by 0.75% and a full 1% percent, respectively. The Bank of England's rates are now at their lowest level in over four centuries.
I'm guessing that the unstated goal of all this rate-slashing is to "re-inflate the bubble" ... political and financial leaders are suddenly a lot more worried about deflation than they are about inflation. And with leverage controls certain to be tightened up in the near future (and rightfully so), lowering interest rates is the only way to prevent a collapse in the global money supply. But now I'm wondering two things. One, doesn't this mean we're trapped ... essentially, "addicted" to low interest rates? They're being pushed to such a low level that they're losing their effectiveness as a macroeconomic control. And two, is this a bad thing? Or at the very least, won't it mean a major shift in the way money, capital, and debt is allocated?
4 comments:
Yes, yes, and yes. (Yes on addicted to low rates, yes it's a bad thing or at least less efficient, and yes it will be a shift in the way the economy works.)
Fed control of interest rates is effectively central planning. And once they lower the overnight rate (they have), then the plan is to move out on the yield curve and force down (by mandate/law) those rates until they get the response they want.
It's unfortunately a lot less efficient from an economic point of view... but it's politically popular and gives everyone a good feeling that "something is being done" instead of letting things work themselves out.
The entire world could do with less credit, but that would mean actually changing, which is apparently painful. And the politicians that are in control (I include Bernanke in this group) will do anything to avoid change when they don't want it.
Peter -- sorry about the last comment, for some reason I thought you grew up in England.
If you keep in touch with old friends... What is the prevailing opinion in Canada with regards to the financial profligacy in the ole USA? Is the central bank on board? I don't seem to see or hear much about Canadian central banks...
Hey, not a problem. And actually, I just got back from a visit to family in Canada, in the Atlantic province of New Brunswick. Canadians view the US much in the same way a little brother views a successful big brother; admiration in private, jealousy in public. When the US suffers, Canadians tend to chuckle a bit and think "serves 'em right". Not in a malevolent way - more like the way an average baseball fan will gloat when the New York Yankees don't make the playoffs. But that Schadenfreude quickly gives way to harsh economic reality. Canada's economy is inexorably tied to the fortunes of the US, and US economic news is automatically Canadian economic news. There's a famous quote by former Prime Minister Pierre Trudeau: "living next to [the United States] is like sleeping with an elephant. No matter how friendly and even-tempered is the beast ... one is affected by every twitch and grunt." Also, Canada has benefited in recent years from the commodities bubble, and that bubble's collapse is hurting, too.
The average Canadian automatically thinks of one thing when considering its economic relationship with the US; the US-Canadian dollar exchange rate. Earlier this year, both dollars were at "par" value; for a while, the Canadian dollar was worth slightly more. That hadn't happened since the 1970's, and it fueled a certain smugness north of the border. But in the past few months, the Canadian dollar has plummetted back to a historically typical level of about 80 cents US. This is actually desirable in Canada, since the economy depends so much upon exports to the US, but Canadian consumers don't like it. Bank of Canada interest rate policy is usually in line with US Fed policy, since the two economies are so closely linked, but that's not a hard-set rule. While the central bank concerns itself chiefly with inflation, it also has a big unwritten duty to maintain a stable relationship between the US and Canadian currencies.
In short, Canada follows American economic news and bank policy, and more or less mirrors it, but grudgingly feels like they're not in control of their own destiny. Canada knows that it can't prosper unless the US is prospering, so they're concerned about things down here. Although when they hear Americans panicking about a projected 8% employment rate, they probably laugh. The unemployment rate is always several percentage points higher in Canada. In my home province of New Brunswick, it's routinely above 10%. Ain't socialism wonderful?
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