You are here: Home » Political Economy » I repeat: The Fed’s Permanent Zero rate policy is toxic
Here’s my position on Bernanke’s rate easing: in conjunction with Obama’s attempts to revive mortgage lending for underwater homeowners, it can definitely give a good kick to the economy. rates will be lower and that actually drains interest income out of the economy. But if those lower rates translate into huge refi activity, then they turn from a drain to a huge stimulus fill-up.
Here’s what I said about rate easing and permanent zero last August:
What the Fed has done is told us it would keep the Fed Funds rate at effectively zero percent through mid-2013, two years from now. This is one step short of ‘rate easing’, the term I am using to describe a Central Bank’s targeting a specific non-policy rate, a form of quantitative easing where the Fed targets price instead of quantity.
While rate easing and its cousin permanent zero might have some salutary effect in the short term, these policies are toxic to the financial sector and consumption demand. Likely, they will not spur the economy but lead to a deepening malaise.
-Why Permanent Zero is toxic and leads to depression
Basically, low rates steal interest income from savers and fixed-income investors and give it to borrowers. It’s as if the Fed reached into your pocket and stole money from you and gave it to the over-leveraged guy down the street drowning in a mountain of debt. Clearly, that’s what moral hazard is all about (and so I don’t advocate the Fed’s zero interest rate policy).
Here’s the thing though. If more borrowing doesn’t occur, it is a net drag on the economy. Since we know that loans create deposits, which end up increasing reserve balances – not the other way around – low rates are entirely dependent on the demand for credit not on the supply of credit.
If President Obama is socialising mortgage losses ahead of the November election via what are effectively cramdowns at Fannie Mae and Freddie Mac then you are going to see some serious refi activity from underwater borrowers. That’s bullish. And that’s what my weekly post was all about.
More at Credit Writedowns Pro. But remember, households are still over-levered and interest rates cannot be stimulative since they are zero percent. When the next recession hits and the yield curve is still flat as a pancake, bad things are going to happen. That’s why I have to remind you how toxic this policy is.
Permanent zero can work over the medium-term if you get refis but longer-term, the economy is dependent on wage and employment growth and monetary policy doesn’t drive that.
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