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24 August 2011
Easy Money Is a Mixed Blessing
finance.yahoo.com One won't get a confession from Fed Chairman Bernanke
Will Ben Bernanke fess up at Jackson Hole?
This week Federal Reserve chair Ben Bernanke journeys to Jackson Hole to address the annual confab organized by the Kansas City Fed. He will discuss the state of the economy and what, if anything, the central bank intends to do about it.
As you know, his audience will consist of more than those in attendance. Indeed, bankers, economists and the financial markets around the world will parse his every word, looking for signs that the Fed will ease even more than it already has.
They may or may not get such a sign but one thing you can be sure that they won't get is an admission that the Fed's current degree of ease may well be doing more harm than good.
That's right, fans, it may come as somewhat of a shock but easy money is not nirvana. That said, the big question is will the Fed head talk about the perils of easy money as well as its attributes?
What's that? You can't imagine that too much of a good thing can be wonderful? Well it can, when it comes to easy money; here are just a few examples.
The first consequence that comes to mind is the potential for easy money to cause inflation. As economist Milton Friedman used to say, "Inflation is first and foremost a monetary phenomenon."
The liquidity that the Fed has already injected into the economy has hurt the fledgling recovery by enabling prices of such key staples as food and energy to rise, thus draining consumers' buying power — if not their confidence.
At the same time, low interest rates have hurt savers — especially seniors and retirees who have to get by on fixed incomes.
Case in point: Yields on such savings instruments as certificates of deposit have fallen from 3.78% for a one-year CD back in 2006 to a meager 0.42% today, according to Bankrate.com. And for those who put their cash into one-week money market funds, their return is just about zero — 0.01%, to be exact.
Needless to say, companies that are sitting on huge piles of cash are also earning next to nothing. The same goes for pension funds and insurance companies.
In the case of pension funds, many of them assume that they will earn an average of 8% a year. However, lower stock prices combined with today's extremely low interest rates are leaving many of their plans underfunded.
Insurance companies, too, depend on income from investments when setting premiums. They are redesigning and repricing some of their products in order to regain some lost income.
The banks don't do well in a low-rate environment, since their usual way of making money, borrowing short at low interest rates and lending long at higher rates, is limited by the flattening of the yield curve.
In other words — the spread between long rates and short rates is much less than usual because monetary policy is so easy, so it doesn't pay for the banks assume the risks that come with lending.
Speaking of borrowing, many potential home buyers don't feel compelled to bid on a house if they think they can get a lower price by waiting. This is because they are not worried that they will miss out on low interest rates — thanks to the Fed's statement that it plans to hold rates down for at least two more years.
This pledge concerns business people, for they take it as a sign that the Fed is very worried about the economy. And if the money mavens are worried, how can the typical executive not be worried as well?
Easy money may have helped the economy in the past, but it does not appear to be of much help this time. So how should we judge current monetary policy?
I would give it a B, at best. It's not a great grade, but it's a lot better than the grade I would give today's fiscal policy — a failure.
Irwin Kellner is MarketWatch's chief economist.
