The View From 1776

Fed Feeds Distortion

Bernanke’s press conference announcement again booted the stock and bond markets, but did nothing to boost employment.

At his January 25, 2012, press conference, Federal Reserve Bank chairman Ben Bernanke stated that he expects the Fed to continue imposing near-zero interest rates well into 2014 on short-term Treasury securities.  In response, the stock market surged, despite expectations of generally lower corporate earnings and reduced consumer spending.  Loose credit and low interest rates usually facilitate stock market speculation.

However gratifying this may to individual investors and pension fund managers, it does little if anything to restore production of goods and services or to raise employment.  It also continues to penalize increased savings, which alone provides a stable, long-term platform for economic growth.  People living on fixed incomes have had their rates of income on saving chopped around 75% since the Fed first cut interest rates.

As Austrian school economists long have observed, central bank manipulation of interest rates and government deficit spending has an uneven impact on sectors of the economy.  When unemployment is high and people are yet freighted with excessive personal debt, consumer spending will be among the last sectors to increase.  Instead, deficit spending and loose money lead businessmen to over-invest in long term capital goods, because low interest cost for borrowed money makes even marginal investment projects appear profitable.  When business finally revives and costs, including interest rates, increase, those marginal projects collapse and push the economy into recession.

Such was the genesis and progress of the housing bubble and subprime mortgage securities. 

Contrary to the aggregate computer models of Keynesian economics, the economy as a whole never has been controllable via government stimulus spending. In fact, as reported recently, the 31% increase in business long-term investment over recent months has been largely concentrated in labor-saving equipment, which ironically adds to unemployment or postpones new hiring.