Artificially low interest rates bad for economy

Ultra-low interest rates fueled the housing bubble, thanks to former Fed chairman Alan Greenspan’s direction. And Americans should brace for another crash because that practice has continued.

The Federal Reserve’s Open Market Committee recently announced it would maintain a target of zero to 0.25 percent for the federal funds rate — the interest rate banks charge each other for overnight loans of reserves. It has now been a full 15 months that Ben Bernanke’s Fed has kept that key rate at basically zero.

Although it seems quaint from our current perspective, the popping of the dot-com bubble in 2000 led analysts to expect a severe recession. And yet somehow Greenspan managed to provide a “soft landing.”

In retrospect, a growing number of economists and financial analysts believe that Greenspan simply kicked the can down the road and set up the U.S. economy for an even greater recession. In order to stave off the pain from the dot-com crash, Greenspan had cut the target for the federal funds rate from 6.5 percent in early 2001 down to 1 percent by June 2003.

Greenspan held the federal funds rate at 1 percent for a full year — the lowest it had been in more than 40 years — after which he gradually hiked it back up.

Of course, the housing boom occurred not just in the United States, but in many countries. Something so large and widespread was not due to any single cause. Even so, Greenspan’s ultra-low interest rates — fueled by the injection of newly created money into the credit markets — were a necessary condition for the mania that swept the financial world in the mid-2000s.

Tragically, Bernanke has decided to one-up Greenspan. Bernanke has brought interest rates down to almost zero and held them there for 15 months. And that’s expected to continue.

On the monetary side, Bernanke’s actions are more alarming. He has allowed the Federal Reserve to write checks — drawn on thin air — to the tune of $1.25 trillion to buy dodgy assets tied to mortgages. He has also been a huge buyer of debt issued by the federal government.

The Federal Reserve and its supporters claim that the unprecedented interventions rescued the financial markets and the housing sector. Also, they point to the moderate consumer price inflation for the past year as evidence that the Fed isn’t “overheating” the economy.

Yet these are exactly the same excuses from the Greenspan era.

It is now obvious that housing prices during the mid-2000s were completely divorced from reality and that the U.S. economy was in an unsustainable dreamland. Five years from now, Americans may look back and think the same was true of 2010.

Printing money to keep zero percent interest rates has never worked long term, will only postpone the inevitable correction, and indeed make another crash more likely.

Robert P. Murphy is a senior fellow in business and economic studies at the California-based Pacific Research Institute. Send comments to [email protected].

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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