December 16, 2018

HOMO ECONOMICUS IS DEAD:

Ten years on, Fed's long, strange, trip to zero redefined central banking (Howard Schneider, 12/16/18, Reuters)

The Fed was not the first to employ such an aggressive response to an economic downturn. The Bank of Japan adopted ZIRP in the 1990s in response to a collapse in its real estate market that helped trigger a decade of economic stagnation. 

There was nowhere else to go. From July 2007 to the fall of 2008, the Fed had trimmed its target policy rate from 5.25 percent to 1 percent.

The economy was so weak that many models indicated the appropriate interest rate for the Fed would have been negative - in effect a tax on savings that might prompt people to spend. While theoretically possible and in fact later adopted by a few central banks elsewhere, negative interest rates would have been a political non-starter in the U.S. Congress, and difficult to sell to the public in a fast-moving crisis.

Instead, a dramatic Fed action drove the policy rate to a range of between zero and 0.25 percent. It was, in effect, a zero rate, but more importantly demonstrated the Fed's willingness to go to extremes. [...]

The unemployment rate is at its lowest in nearly 50 years. Inflation is hovering around the Fed's target. A near decade of economic growth will become the longest expansion on record next year.

What's not to like?

It took seven years for the Fed to leave the zero lower bound, and rates are still abnormally low. By some accounts, consumers and businesses may be addicted to cheap money, and so sensitive to interest rates their willingness to buy homes or invest may fall off more quickly than in the past as rates rise.

Note that the core assumption here is that consumers do not react rationally to a widening divide between the interest rate and the rate of inflation/deflation.  The fact is that prices crashed so much after the Credit Crunch that zero was usurious.

Posted by at December 16, 2018 9:13 AM

  

« CELEBRATE BOTH: | Main | CAREFUL WHAT YOU WISH FOR: »