First, as I said previously, the Fed’s actions have not lowered rates. The Fed’s QE2 raised inflation expectations, causing interest rates to rise and nullifying the effects of lowered risk premia. Second, low rates are toxic to savers and bank net interest margins. When credit demand is weak, the loss of interest income overwhelms the reflationary effects of low rates. Third, as Yellen herself has noted, it is conceivable that accommodative monetary policy could provide tinder for a buildup of leverage. Low rates encourage releveraging, not deleveraging.Despite having have been highlighted previously, these points are worth rehashing. Edward’s conclusion succinctly states the real problem that needs to be addressed:
the demand for credit is still weak. Some point to the importance of the psychology of balance sheet recessions. Others like myself point to the debt stress from falling asset prices and weak job and income growth. Either way, absent a rebound in incomes or a reduction in private debt, the recovery will remain weak irrespective of how many supply side solutions the Fed implements. If the US (the UK, Ireland or Spain) wants to get the credit ‘transmission mechanism’ working again they will need to increase demand for credit by reducing real debt burdens as a percentage of income or increase income and job security enough to allow debtor’s to focus instead on today’s low debt service costs. If these countries focus on deleveraging instead of releveraging, that would necessarily mean large private surpluses and therefore large government deficits in the absence of significant currency depreciation.
Bottom line: The real solution has nothing to do with the Fed because the constraints are demand side and not supply side. But people will continue to exhort the Fed to do more and so they will do more.