FED will not be able to deal with next recession

ZIRP has basically made the FED impotent when it comes to dealing with the next recession. The only real tool the FED has when it comes to stimulating the economy is to lower interest rates which are currently basically at zero.

ZIRP was intended to be an emergency measure to deal with a catastrophic situation, but 7 years later is still in place trying to artificially pump an economy which is faltering in spite of extreme stimulus.

The really dangerous part of all this though, is that when, not if the economy slips back into negative territory in not too distant future, the FED will have no powder left to battle with. That is unless you think it is reasonable to think they will pay you to borrow money.

 

Alas, that is news only to Obama supporters and to the average Dem Party voter and yet because they BELIEVE in the power of wishful thinking as a substitute for meaningful policies . . their attitude is "What? Me worry?" I sort of admire them for their ability to function with their heads permanently residing inside a hole in the sand.

 

The FED can't just magically set interest rates to whatever it wants with the flip of a switch. It costs a huge amount of money to alter market interest rates, and if the FED attempts to set interest rates over a prolonged period of time, that will result in inflation, effectively reducing the purchasing power of the Treasury.

 

The biggest problem is the Fed cannot induce demand in an economy, and that is single handedly the largest problem we face. Low demand kills jobs and reduces overall available money to spend on goods and services. Cheap money and QE have already proven not to help, although they've made quite an investment bubble of the stock market.

 

The idea behind QE was to prop up the asset prices in the market, hopefully letting the bubble that had already formed slowly deflate.

Sub-market interest rates basically encourage "bubble" behavior. If someone is loaning you free money, why not use that money to make investments to get a higher rate or return? The danger, of course, is if those interest rates suddenly go up. Then you could basically be stuck with an investment that has rapidly depreciated in price. Subsidized interest rates mean higher prices, because borrowers can bid up the price in an attempt to make profit. By trying to lower interest rates, the FED is basically incentivizing people to buy investments, the downside is investors cannot be sure how long those incentives will actually last. But it's the perfect recipe to try to counteract a panic, because the market is often not completely rational and tends to make the assumption that current conditions will just continue on as they have been.

Most of this QE, however, was simply the FED buying government debt, because there was not enough demand for it in the market. With all the deficit spending, the U.S. Treasury needed someone to lend it all this money at low interest rates. This is course dilutes the value of the dollar.

 

The FED can and does set interest rates with the flip of a switch, but that is not the point, the point is that lowering interest rates is the only bullet the FED has to battle recession and it has already used it. With interest rates basically at zero presently and economic indicators slipping into recession territory, the FED is powerless to stop a recession when it begins.
That is the downside of artificially manipulating the economy, if it does not work the results are worse than if you had let the economy correct itself in the first place.

 

The fed can lower interest rates to zero, which when combined with inflation, could push us down to -1.5-2% interest.

The fed has other tools--they just are not pretty tools. They could intentionally devalue the US dollar, for instance.

Our problem is not the fed but the GOP in the Congress refusing to spend some money as far as GDP. As I have said before, I personally do not mind the economy shrinking, but to the extent that people get freaked out over it, that causes a problem.

 

we've spent 100's of trillions too much already.

 

Well not quite "100's of trillions", but it's definitely in the trillions—which is no small sum of money.

 

diluting the value of the dollar is another way of saying inflation
which has not been a problem during qe


in fact the value of the dollar is high vs other currencies, the price of gold and the price of oil

 

Its true that despite the massive increase in money via QE, price increases have not matched the amount of money printed.

The St. Louis Fed has a good research department, they addressed the issue here:

https://www.stlouisfed.org/On-The-E...elocity-Tell-Us-about-Low-Inflation-in-the-US

What Does Money Velocity Tell Us about Low Inflation in the U.S.?
Monday, September 01, 2014

"During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q).

So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows.

And why then would people suddenly decide to hoard money instead of spend it? A possible answer lies in the combination of two issues:
•A glooming economy after the financial crisis
•The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds

In this regard, the unconventional monetary policy has reinforced the recession by stimulating the private sector’s money demand through pursuing an excessively low interest rate policy (i.e., the zero-interest rate policy).3"​

The Fed and US Treasury are caught in a trap of their own (unintentional) making. They are injecting vast amounts of money into the economy in hopes of spurring economic activity and creating a true recovery, but people/banks/businesses are not playing the game and are sitting on the money. The Fed cannot retract that money from the economy without panicking people as they did earlier this year at just the hint of a rate increase.

The true danger is that the economy starts a true recovery, people start spending, costs start increasing out of control. The Fed/Treasury hope they can raise rates quickly enough to keep the recovery cool enough to keep prices in check, but don't raise rates so fast that it kills the recovery. Do you trust the govt to respond quickly and appropriately? I don't.

 

The only flaw in the above is the Fed isn't incentivizing the citizens to invest at all, except as a side effect of pumping banks with liquidity that, instead of being loaned, is parked in the investment markets. Citizens respond by adding to investment capital when market prices climb so they can also enjoy the growth in investment values. The problem is in knowing where the real values lie, and banks will jump out of the markets at a faster rate, and earlier, than household investors, which will lead to another major loss for individual savings once the bubble bursts.

QE was an asset swap between the fed and the commercial banks, giving them liquidity (credit) in return for their junk MBS and outstanding treasuries. So we've shifted some debt and crappy investments onto the Fed's balance sheet while transferring real (digital) money to the banks in return. It's a theoretical net-zero, but the reality is those worthless MBS are a loss for the Fed and a gain for the banks. Worst of all, that additional liquidity was meant to stimulate loans to consumers and businesses, which didn't happen. Instead, the banks took the low risk route and invested. They knew when the banks all started hitting the investment markets that prices would climb and they would reap huge rewards in investment value gains. When they (commercial banks) pull the plug and sell of large amounts of investments if markets turn negative, the opposite will happen and it'll be us lowly individual investors who will lose big.

 

of course it's hundreds of trillions. the fed expenditure has been over 10 trillion per YEAR for decades now and 90% of it was either a waste or a negative for us.

 

the FED cannot spend $10 trillion a year, as they only have around $3 trillion to actually spend.

you're triple, and quadruple counting the same money.

this reminds me of how folks claims we spent $15 trillion in bail outs, when we actually spend less than $800 billion. It was due to the govt. spending the same money multiple times.

 

The value of the currency gets diluted whenever the Central Bank (the FED in this case) dilutes the value of its Reserve Assets being held. The value of the Reserve Assets get diluted anytime the Central Bank gets a below-market rate of return on their assets. In other words, the Bank essentially has to keep running just to stay in place. They cannot expand the money supply and just buy up assets without that causing inflation. People want to use those assets to gain an interest rate, and that factors into the price of those assets. But as long as the Central Bank collects an adequate interest rate, their total Reserve Assets can balance out the new money they created to buy the assets in the first place.

 

if we have another recession, we will do more QE

 

What do you think happens if the Central Bank does too much QE ?
Inflation, monetization of government debt?

 

QE causes inflation.

cause it devalues our currency.

therefore prices go up.

 

I don't hear Republicans critcising this system. I believe this is happening everywhere in the government as well as in finance and business, especially since a fluffed-up, paper-based economy such as we have now works by faith. Keep saying it's working and it keeps working! It seems it won't fail as long as most people don't want it to since all problems can be papered over with fresh money printing..

 

Everyone Right of Center that I speak to expects to see another major recession hit this nation fairly soon. Every Left of Center that I speak to says, "Wow dude! Everything is just beautiful and perfect. Obama fixed everything!"

 

I also hear it right of center, though only among ordinary people and some people involved in the markets. To be clear, I only mean that the politicians seem to be keeping mum about it if they share these views.

And yeah, the lefties are totally clueless about it. I'm thinking a lot of them just don't have a head for business and economics.

 

Well the Right of Center politicians know that they will instantly be attacked by the nation's left-aligned Mainstream Media if they badmouth the economy and predict bad things in store for the future. True they should show some spine, but then again they ARE politicians and therefore are almost universally a waste of space.

 

Wow, lower the interest rate to zero? a whole .25% that would have a major impact....not. How exactly would devaluing the dollar help the economy? Does having the value of your paycheck devalued make you want to spend money? And how much money that Congress does not have would be enough to satisfy you. Enough to where the entire budget would only cover interest on the debt?

 

We would only need to have a major impact if we had a major recession. The next one won't be, so "major impact" is pointless and an attempt to move the goalpost.

It creates jobs and encourages exports.

Yes, just on different things than I am now.

I don't think we should pay the national debt at all. We should default and take the money and invest it in foreign currencies. At 25% of the global GDP, people will still need dollars and do business with America

 

You have been smoking too much ghanga. You neither have a grasp of economics nor reality.