The Fed Undertakes a Useless Policy to Stimulate the Economy

Their Grade – A for Effort, F for Effectiveness

After finally recognizing what has been obvious to everyone else for months, that the economy is stalled and new job creation is anemic, the Federal Reserve announced that it would embark on a policy of buying more bonds.  The idea is to drive interest rates even lower than they are today, and so stimulate borrowing and investing. 

The Federal Reserve opened a new chapter Thursday in its efforts to stimulate the economy, saying that it intends to buy large quantities of mortgage bonds, and potentially other assets, until the job market improves substantially.

The Fed also announced that they would keep interest rates low through  mid 2015.  The effect of all of this will be   . . . .  nada, zip, zilch, less than nothing, zero,  etc.

Economic policy is not symmetric, so while it is true that raising interest rates and restricting the availability of credit will slow an economy, lowering interest rates and increasing the availability of credit will not stimulate an economy.  Why not?  Because the economy is demand driven.  Even if the cost to borrow money is low business will not invest in new capacity or hire new workers if there is no demand for the additional production. 

Furthermore lower interest rates is a two edged sword.  Yes it does make borrowing less expensive, but it also reduces interest income to savers, retirees and anyone else who has interest bearing investments.  This in turn reduces demand and offsets much if not all of the positive impact of lower interest rates.  It is a part of the economic policy equation that is almost never addressed by those who support lower rates.

The Fed’s signal to keep rates low for a long time is a fairly useless gesture.  First of all the Fed is not bound by this promise, if for some reason they change their minds, well they change their minds.  Also, with low rates forecast for the medium term there is no reason for fixed rate borrowers to borrow now, they can always get the low rates or even lower rates in the future.  So that part of the policy is largely self-defeating.

So why do all of this?  Because in the real world the government, including the Fed must be seen as trying to do something.  Even if that something is nothing.