The Federal Reserve announced their plans earlier this month explaining how they intend to stabilize an economy with an addiction to volatility. Chairman of the Federal Reserve Ben Bernanke announced they plan on keeping interest rates at close to zero until mid-2013. Bernanke and friends hope by guaranteeing these low rates for two years businesses and citizens will be inspired to borrow more money. If there is anything the market loves, it is certainty, and they hope a two-year promise will keep the recovery moving forward. The thing is, by publicly announcing such a commitment to a set length of time, their plans could backfire.
This decision is in response to a summer almost as disappointing to the Fed as our weather was to us. Since their last statement in June, the Federal Open Market Committee's tone has changed remarkably. In June, the economy was recovering at a “moderate pace.” In August, it was, “considerably slower than the Committee had expected.” From “household spending (continuing) to expand,” to “Household spending has flattened out.” From the recovery picking up its pace, to it slowly, gradually, maybe considering picking up its pace. The Federal Reserve, like most of us up here in the Pacific Northwest, was hoping for a nicer summer.
Thus, they have publicly decreed that the Federal Reserve intends to keep interest rates at zero to 0.25 percent. This promise is a pretty blatant plea to the American populace and businesses. The Federal Reserve would really appreciate it if people started borrowing money again.
Unfortunately, by declaring a specific time frame this announcement could have the complete opposite effect. For a while now the Fed has kept interest rates low to encourage borrowing. As many college students realize, the costs of loans are solely determined by the interest rates associated with them. Thus, lower interest rates means borrowing money is cheaper. Meaning consumers and corporations will be more inclined to borrow money, which in turn will stimulate the economy. This relationship is well established in the financial world.
But this situation is different. Interest rates have been absurdly low for some time now while the market continues to cause investors some worry. The past hiccup with Standard & Poor's credit rating caused tremors any investor would be wary of. This announcement does little more than tell the potential borrower to wait it out for two years and see what happens.
Take for instance the newlywed who is getting ready to start a family. Sure he has the American dream of a white picket fence burning in his head, but he just got word that in two years interest rates will be just as low. Perhaps it would be better to wait and see just how low home prices can go. This is the game of limbo the Federal Reserve was hoping to avoid.
The other aspect of this decision was to inspire companies to start investing and spending money. The funny thing is, according to Federal Reserve data, non-financial corporations are holding a record $1.9 trillion in cash and liquid assets. I doubt not having enough cheap money available is what is holding their spending back. It is the roller coaster that is the Dow Jones weekly summary that binds their hands.
Let us not forget the Americans who were not raised to spend money they do not have. The Americans who diligently put money into their savings, CD or Money Market account. For us, these low rates cut off the flow of money and do little to encourage spending. Less income means less spending. It's cause and effect, really.
I would like to see the Feds announce they will be raising rates. Give it a 6-month period and see how many people on the verge of borrowing they can tip over the edge. Because let us be honest here, that is who they are appealing to. Our newlywed would borrow now to capture these low rates. Businesses, too, would be compelled to take advantage of the situation and start spending. If anything, it would make me feel less like crying every time I look at my savings account and see 0.42 percent.