Thursday, June 23, 2011

The Fed Says Let the Bad Times Keep Rollin'

The Federal Open Market Committee announced yesterday that they will keep up record monetary stimulus after QE2 finishes. They correctly see that the economy is still stagnant and unemployment is still high. Ben Bernanke says the pace of recovery is "frustratingly slow." In a moment of honestly he revealed, “We don’t have a precise read on why this slower rate of growth is persisting.”

An important reason the Fed remains mystified is its basically Keynesian economic framework. This framework leads them to think spending, and especially consumer spending, is the driver of the economy. The monetary base remains at historically high levels, because the Fed thinks that by pumping such a large amount of money into bank reserves, banks will feel comfortable to lend, entrepreneurs and potential home buyers will feel comfortable borrowing, and spending will increase across the board. This, so the theory goes, will boost incomes and national GDP. It is the theory that we can achieve prosperity through printing press.

In fact, what drives the economy is voluntary savings and investment which funds capital accumulation, entrepreneurial activity, and research and development. Artificially lowering interest rates during QE ad infinitum merely perpetuates capital malinvestment, retarding productivity and prosperity. 

Also yesterday the always interesting James Grant provided some expert commentary on Fed policy on "In Business with Margaret Brennan" on Bloomberg TV.

He notes that what the Fed has in fact achieved through QE2 is a weaker dollar, a higher gold price, slower economic growth, and higher price inflation.. Additionally the Fed has managed the artificially prop up stock prices. In speaking to that consequence, he surmises that either the Fed owns the stock market or the stock market owns the Fed.

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