Low Rates, the Federal Reserve and the Slow Economy

Original Article

The recent release of the Federal Reserve’s minutes from meetings in the fourth quarter of 2007 reveal how little the Bernanke Fed understood before the 2008 financial collapse. Similarly, the Greenspan Fed failed to grasp the risks that led to the earlier stock exchange and housing bubbles bursting. John Taylor makes a similar point (“Fed Policy Is a Drag on the Economy,” op-ed, Jan. 29), arguing that today’s Fed is oblivious to the risks of its prolonged zero-interest-rate policy.

One of his key points—that “extraordinarily low rates support and feed the spending appetites of Congress and the president and, increasing deficits and debt”—should be well understood. In effect, the Fed is now the locus of increasing systemic risk by serving as the handmaiden of a new bubble in U.S. government bonds—the result of trillion-dollar deficits from irresponsible fiscal policy and delayed entitlement reform.

Total U.S. government debt in the form of interest-bearing bonds and IOUs to Social Security and Medicare trust funds grew 53% during the last four years—from $10.7 trillion to $16.4 trillion—and is now 104% of U.S. GDP. Due to the Fed’s massive quantitative easing bond-purchasing programs, today’s blended cost of government borrowing is 1.96%, much less than the historical average market rate of about 5.5%. By staying on the current trajectory of debt monetization and thwarting credit-market price signals, the Fed is setting the stage for this new bubble to burst. It may come from resurgent inflation, the Fed’s sudden need to defend the dollar or the credit-rating agencies’ downgrade of the U.S. As a result, there would be a sharp decline in the standard of living for all Americans, accompanied by regret for having ignored the warning signs when there still had been time.

Scott S. Powell

Senior Fellow, Center on Wealth and Poverty
Scott Powell has enjoyed a career split between theory and practice with over 25 years of experience as an entrepreneur and rainmaker in several industries. He joins the Discovery Institute after having been a fellow at Stanford’s Hoover Institution for six years and serving as a managing partner at a consulting firm, RemingtonRand. His research and writing has resulted in over 250 published articles on economics, business and regulation. Scott Powell graduated from the University of Chicago with honors (B.A. and M.A.) and received his Ph.D. in political and economic theory from Boston University in 1987, writing his dissertation on the determinants of entrepreneurial activity and economic growth.