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Obama Ignores Pernicious Effect of Fed Policies

August 8, 2013 in Economics

By James A. Dorn

James A. Dorn

When President Obama gave his recent address at Knox College, he lamented the dismal state of middle-income families, whose real incomes have been stagnant or falling. He promised new policies that would restore upward mobility and improve prospects for growth and employment.

However, he ignored the negative effects of the Federal Reserve’s unconventional monetary policies.

The Fed’s decision to hold its target interest rate near zero until at least mid-2015, and to continue quantitative easing until inflation reaches 2.5% and unemployment falls to 6.5%, is meant to stimulate investment and consumption.

According to Fed Chairman Ben Bernanke, “Highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy.”

Current U.S. fiscal and monetary policies are myopic.”

In reality, the Fed’s ultra-low interest rate policy and QE have underpriced risk, distorted capital markets and had little impact on increasing economic growth and employment.

Bernanke’s “portfolio-balance approach” designed to boost asset prices and spending has worked for some, as seen by the rising stock market.

However, he has underestimated the negative effects, and President Obama has been silent. By holding the federal funds target rate at near zero since Dec. 16, 2008, and suppressing yields on U.S. government securities, the Fed has helped finance the large fiscal deficits while engaging in financial repression — that is, holding nominal interest rates so low that real after-tax interest rates turn negative.

In so doing, the Fed has hurt middle-class families and retirees who have saved for the future. They get virtually nothing on their lifetime savings while the Fed induces people to buy riskier junk bonds, stocks and commodities.

People may also decide to consume more, save less and borrow more for cars, homes and other goods.

By purchasing mortgage-backed securities (MBS) and allocating credit to the politically favored housing sector, the Fed is engaging in credit policy.

Moreover, by paying interest on excess reserves, the Fed has sterilized most of the massive increase in the monetary base (currency held by the public plus bank reserves).

Meanwhile, low interest rates have made banks less willing to make loans, especially to small businesses.

In a normal economy, under conventional monetary policy, increases in base money would be lent out and lead to a multiple increase in the monetary aggregates, boasting nominal income.

That has not happened under Bernanke’s unconventional policies.

The Fed’s biggest mistake has been to downplay the adverse consequences of its zero interest rate policy and …read more

Source: OP-EDS

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