WASHINGTON: In 2007, as the economy was slowing and about the enter a very severe recession, the Federal Reserve (FED) began to cut interest rates. At the time, the Federal Funds rate was 5.25%. By the end of 2008, the rate was near zero.
At the same time, the FED began to massively increase the money supply.
While most economists credit the FED’s Monetary policy for putting an end to the recession, the policy never led to an expansion. In theory, as a result of the FED’s actions, either economic growth should have increased significantly or there should have been a large inflation problem. Neither happened.
Monetary policy did not work the way it was supposed to.
The reason for this is that Monetary Policy will have a stimulative impact on the economy only if there is a multiplying effect on the overall money supply. The multiplying effect occurs when banks lend money to consumers and the business community. Because Congress passed the Dodd/Frank bill in 2010, lending was severely curtailed.
No lending meant no multiplying effect. No multiplying effect severely minimizes the impact of Monetary policy on the entire economy. As a result, the economy continued to show meager 2% growth for the next decade, while inflation remained very tame.
Last year Congress reversed much of the negative impact of the Dodd/Frank bill. That action freed banks to make loans. Couple that with the tax cut Congress passed in 2017 and the economy should have seen rapid economic growth. Growth increased only to a rate of just under 3%.
The growth rate should have been much higher. The FEDS’s more than two years restrictive Monetary Policy, which has increased the interest expense for business by as much as 50%, is placing a burden on economic growth.
Because interest rates were reduced to near zero in 2008, by 2016 the FED felt it was time to raise rates to more normal historical levels, even though the economy never entered an expansion, while growth remained in the 2% range and there was no sign of inflation. They said their reason was that the low rates would mean the FED couldn’t reduce rates any further should the economy slow down in the near future.
FED starts raising rates in 2016.
Between the end of 2016 and the end of 2018, the FED raised rates nine times. After seven of those raises, this policy began to slow economic growth. In the second quarter of 2018, the economy grew at more than a 4% rate. Finally, it appeared, the economy was entering an expansion. So what did the FED do? They raised interest rates again and again.
The result was that economic growth did slow to just over 3% in the third quarter and then just over 2% in the fourth quarter. Finally, in early 2019 the FED said they would not raise interest rates at all for 2019. That’s good for the economy, but it’s not nearly good enough.
Last year, President Trump said interest rates should not be increased at this time. More recently Larry Kudlow, Trump’s chief economic advisor said the FED should “immediately” cut interest rates by half of a percentage point. That would have a very positive effect on economic growth almost immediately.
Former FED chairperson Janet Yellen agrees. She says that the recent weakness in the economy coupled with weakness in the global economy should lead the FED to cut interest rates. Yellen notes that the relationship between short term interest rates and long term interest rates (the yield curve) further indicates it’s time for an interest rate cut.
There are no signs of inflation.
Even though interest rates are still low by historical standards and the FED’s balance sheet may need some restructuring, monetary policy should set growth as the number one priority. Because the tax cut was supply-side oriented and because productivity is only slightly less than wage increases, inflation shouldn’t be a problem.
Growth should be the highest priority since the US has not seen annual growth of at least 3% since 2005. We haven’t seen a prosperity growth rate of at least 4% since 2000. That is the longest period of continued economic stagnation in history. This lack of growth, which means a lack of opportunity, has led to many of our social problems and is really the basis of the appeal of Socialism to millennials.
Let’s set a Monetary Policy to focus on economic growth. Cut the interest rate now!