NCPA - National Center for Policy Analysis

Pro-Growth Tools for the Frozen Fed

October 14, 2015

After the lackluster September jobs report the Federal Reserve is less likely to end its near-zero interest rate policy. However, it is vital that the Fed consider other growth-oriented options such as tapering its huge bond reinvestment program, shifting some of its borrowing away from banks to encourage lending or shortening the maturity of its bond portfolio to relieve illiquidity.

The Fed says that it is still considering a rate increase in 2015 if the economy and inflation accelerate, but recent data show the opposite.  Moreover, it needs to offset the drag from years of poor U.S. tax and spending policies.

The Fed's theory that low interest rates will cause solid growth has been disproved repeatedly:

  • The current unemployment rate of 5.1% excludes millions who have given up looking for a job but includes millions of part-time workers.
  • The underemployment rate is 10%, twice the official unemployment rate and labor participation is just 59.2%, four percent below normal.
  • With meager credit growth and sluggish business formation, the U.S. economy is suffering from stalled productivity and declining profits.
  • The interbank market, which used to move funds from banks with extra deposits to those with demand for loans, remains frozen, leaving local businesses without access to credit.

Furthermore, this policy failed in 2003-06, when the Fed held rates at 1%, which channeled credit into the housing glut. More balanced growth would have been attained if rates had been higher.

The current policy of near-zero rates combined with direct federal regulation of the quantity of credit doesn't work. It distorts credit markets, misallocates capital and slows economic growth.

Source: David Malpass, "Pro-Growth Tools for the Frozen Fed," Wall Street Journal, October 6, 2015.


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