NCPA - National Center for Policy Analysis

A Classic Case Of Boom And Bust: Now For The Bust

January 9, 2001

Lower interest rates will not bring a recovery, says economist Morgan Reynolds, professor of economics at Texas A&M University and a senior fellow at the National Center for Policy Analysis. That is because the stock market boom in the latter half of the 1990s was fueled by inflation of the money supply. Attempts by the Federal Reserve to stave off the inevitable correction by artificially lowering the cost of money -- interest rates -- will only make matters worse.

  • Officially dated from the end of the first quarter of 1991, our economic expansion is the longest on record, nearly 10 years old now.
  • Since 1995, economic growth has accelerated, and stock prices reached manic levels.
  • The fevered bidding up of stock prices is due to the reckless expansion of money and credit -- conventional measures of money and credit, like M2 and M3, have increased rapidly for years.
  • Most of this artificially created money found its way into assets rather than higher consumer prices.
  • The debt build-up has brought us the highest debt to Gross Domestic Product ratio in history.

Booms create massive distortions and misallocations of capital and labor resources. The longer and more intense the boom, stimulated by easy money, the bigger the distortions and bust that follow.

Interest rates are among the most important signals because they tell us how much consumers want to save for deferred spending versus spending today. Market rates help steer entrepreneurs toward investments that make sense, thereby keeping production in harmony with consumer wants and profit opportunities. Artificially low interest rates distort these signals and always spell trouble down the road.

We don't have a momentary slowdown but a real bust.

Source: Morgan Reynolds, "Alan Greenspan vs. the Physiocrats: No way to recovery," NaitonalReview Online, January 5, 2001.

 

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