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Wednesday, November 18, 2009

Perpetual Zero Rates?

The President of the Fed in St. Louis is hinting that the Fed Funds rate will be at zero until early 2012.

Federal Reserve Bank of St. Louis President James Bullard said past experience suggests policy makers may not start to raise rates until early 2012, while facing a “too low for too long” argument that may “weigh heavily” on the central bank.

“If you look at the last two recessions, in each case the FOMC waited two and a half to three years before we started our tightening campaign,” Bullard said today in a speech in St. Louis. “If we took that as a benchmark, that would put us in the first half of 2012.”

That would mean that this Fed Funds Rate would be at zero for more than four years. To put that into perspective, Alan Greenspan kept the same Fed Funds rate at .75% about a year and a half, and many, like me, believe that loose money policy lead directly to the current mortgage crisis.

We're already facing an unprecedented loose money policy. We're already facing continued zero Fed Funds rate for the indefinite future. Now, that future might not end until 2012.

Giving banks the ability to borrow for nothing leads to all sorts of consequences, namely having those same banks take risks they normally wouldn't. That's good if you want to stimulate the economy but it can also lead to over stimulation. That can lead to inflation and bubbles.

It's clear the Fed doesn't think we're anywhere near a recovery. It also believes that monetary and not fiscal policy will lead us into a recovery. Yet, it also could be a sign of recklessness and desperartion. This sort of monetary stimulus is unheard of. Before Greenspan dropped the fed funds rate below 1%, that was unheard of. Now, Bernanke has not only dropped it to zero but will keep it there at least two and half years and maybe as many as four years.

It doesn't take all that much financial knowledge to know that such looseness in monetary policy leads directly to a new crisis. All such policy requires some semblance of balance. The problem by the Federal Reserve is that its been so aggressive that for each problem solved it created a new problem Greenspan popped the bubble and that caused the recession. Then, Greenspan dropped rates below 1% to get us out of the recession. Now, Bernanke is trying to get us out of this crisis with even more extreme monetary policy.

At some point, some other folks might point out that the Fed is the problem not the solution.

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