Thursday, August 18, 2011

Harrison: Why Permanent Zero is toxic and leads to depression

Recently I discussed the Fed’s decision to suggest interest rates will remain at zero percent for at least another 2 years. Edward Harrison of Credit Writedowns, who’s forecasts have been incredibly accurate the past couple years, offers his thoughts on the topic. Despite taking a different angle, he reaches a similar conclusion. One significant aspect he addresses is the reduction on bank profits due to a flattening yield curve. With fears just beginning to swirl regarding the solvency of a few large banks, loan loss reserves may prove inadequate going forward.

Another focus of the article is the increasing probability that the Fed will be forced to maintain zero percent rates indefinitely. As I noted yesterday, any further expansion of the Fed’s balance sheet will only serve to make permanent zero an even more likely outcome. From a historical perspective, Japan provides the best comparison for a nation maintaining minimal nominal interest rates. At the end, Harrison shows an important correction to previous comments about permanent zero hurting savers. Real interest rates have actually been positive in Japan for a majority of the last decade. Savers, or those invested in government bonds, therefore can actually purchase more goods than 10 years earlier. The notion that inflation is desirable or makes everyone better off appears supplanted in today’s thinking and a future post will take aim at clearing up misconceptions about the positive effect of inflation. For now, I strongly recommend reading the full article to understand potential economic problems that lie ahead.

Why Permanent Zero is toxic and leads to depression

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