Federal Reserve Makes Rate Two-Year Policy, But Current Economic Problems Are Beyond The Fed's Reach

August 2011

The Federal Reserve made a rare promise to hold short-term interest rates near zero through at least the middle of 2013. In so doing, the Federal Reserve admitted that it has given up on the chances for an expansion strong enough to drive up wages and prices. The Fed already has held rates near zero since December 2008.

The Federal Reserve’s August 9, 2011 press release included the following:

“… the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.”

Almost two years from now is a particularly long period for which the Fed to make a prediction as to its policy. While the Fed is no doubt attempting to signal the existence of desirable stability, the same message also signals how weak the economy really is.

The Fed’s press release acknowledged that there was dissent in this policy decision, but the nature of the dissent was glossed over as follows:

“Voting against the action were: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

In the crush of all the important news about the stock market and other economic events, this dissent was missed by most reporting. The vague description did not help. But any meaningful dissent is real news. Mr. Fisher is the president of the Federal Reserve Bank of Dallas, Mr. Kocherlakota is the president of the Federal Reserve Bank of Minneapolis, and Mr. Plosser is the president of the Federal Reserve Bank of Philadelphia. There are seven Federal Reserve District governors on the Committee, so three of the seven people who are closest to business activity objected to the current policy.

Any dissent within the Federal Reserve is unusual, as the Committee tries to act unanimously. The last time the Committee was as deeply divided occurred approximately twenty years ago, in November 1992. At that time three Committee members wanted to begin raising the short-term interest rate, which then stood at 3 percent. 

Mr. Fisher (the President of the Dallas Federal Reserve district) elaborated on the reasons for his dissent in an August 17 speech. His comments are full of important economic statistics, as follows:

“… there is abundant liquidity available to finance economic expansion and job creation in America. The banking system is awash with liquidity. It is a rare day when the discount windows―the lending facilities of the 12 Federal Reserve banks―experience significant activity. Domestic banks are flush; they have on deposit at the 12 Federal Reserve banks some $1.6 trillion in excess reserves, earning a mere 25 basis points―a quarter of 1 percent per annum―rather than earning significantly higher interest rates from making loans to operating businesses. These excess bank reserves are waiting on the sidelines to be lent to businesses. Nondepository financial firms—private equity funds and the like―have substantial amounts of investable cash at their disposal. U.S. corporations are sitting on an abundance of cash―some estimate excess working capital on publicly traded corporations’ books exceeds $1 trillion―well above their working capital needs. Nonpublicly held businesses that are creditworthy have increasing access to bank credit at historically low nominal rates.”

So, why does all of this idle liquidity exist? Mr. Fisher explains:

 “… nonmonetary factors, not monetary policy, are retarding the willingness and ability of job creators to put to work the liquidity that we have provided. … Those with the capacity to hire American workers―small businesses as well as large, publicly traded or private―are immobilized. Not because they lack entrepreneurial zeal or do not wish to grow; not because they can’t access cheap and available credit. Rather, they simply cannot budget or manage for the uncertainty of fiscal and regulatory policy. In an environment where they are already uncertain of potential growth in demand for their goods and services and have yet to see a significant pickup in top-line revenue, there is palpable angst surrounding the cost of doing business. According to my business contacts, the opera buffa of the debt ceiling negotiations compounded this uncertainty, leaving business decision makers frozen in their tracks.

 I would suggest that unless you were on another planet, no consumer with access to a television, radio or the Internet could have escaped hearing their president, senators and their congressperson telling them the sky was falling. With the leadership of the nation―Republicans and Democrats alike―and every talking head in the media making clear hour after hour, day after day in the run-up to Aug. 2 that a financial disaster was lurking around the corner, it does not take much imagination to envision consumers deciding to forego or delay some discretionary expenditure they had planned. Instead, they might well be inclined to hunker down to weather the perfect storm they were being warned was rapidly approaching. Watching the drama as it unfolded, I could imagine consumers turning to each other in millions of households, saying: “Honey, we need to cancel that trip we were planning and that gizmo or service we wanted to buy. We better save more and spend less.

Importantly, from a business operator’s perspective, nothing was clarified, except that there will be undefined change in taxes, spending and subsidies and other fiscal incentives or disincentives. The message was simply that some combination of revenue enhancement and spending growth cutbacks will take place. The particulars are left to one’s imagination and the outcome of deliberations among 12 members of the Legislature.

Now, put yourself in the shoes of a business operator. On the revenue side, you have yet to see a robust recovery in demand; growing your top-line revenue is vexing. You have been driving profits or just maintaining your margins through cost reduction and achieving maximum operating efficiency. You have money in your pocket or a banker increasingly willing to give you credit if and when you decide to expand. But you have no idea where the government will be cutting back on spending, what measures will be taken on the taxation front and how all this will affect your cost structure or customer base. Your most likely reaction is to cross your arms, plant your feet and say: “Show me. I am not going to hire new workers or build a new plant until I have been shown what will come out of this agreement.” Moreover, you might now say to yourself, “I understand from the Federal Reserve that I don’t have to worry about the cost of borrowing for another two years. Given that I don’t know how I am going to be hit by whatever new initiatives the Congress will come up with, but I do know that credit will remain cheap through the next election, what incentive do I have to invest and expand now? Why shouldn’t I wait until the sky is clear?”

Mr. Fisher summarized the outlook as follows. The recent bear stock market is in agreement.

 …It will be devilishly difficult for businesses to commit to adding significantly to their head count or to meaningful capital expansion in the United States until clarity is achieved on the particulars of how Congress will bend the curve of deficit and debt expansion…

The bottom line is that more cheap money from the Fed will not help, because the lack of cheap money has not been a problem. Because the real problem is weak demand for goods and services, lower interest rates promised by the Federal Reserve will not generate further economic activity.

So what will help? Let’s look at the government’s and Federal Reserve’s employment data. For background, the State of New York makes up 72 percent of the economic output of the Fed’s New York District. The State of California makes up 62 percent of the economic output of the Fed’s San Francisco District. The State of Texas makes up 95 percent of the economic output of the Fed’s Dallas District. Here is the data from the Federal Reserve and the Bureau of Labor Statistics (as reported by Mr. Fisher) comparing the employment growth of these three populous districts.

Whether or not the folks in California and New York want to admit it, Mr. Fisher’s Federal Reserve district is soundly outperforming them. Here is Mr. Fisher’s explanation of why this is happening:

 “… people and businesses have been picking up stakes and moving to Texas in significant numbers over a prolonged period. It should be noted that in the last census, Texas gained population and congressional seats, while California’s population growth and congressional representation was static and New York’s was diminished. Jobs have been created for American workers in Texas in several different sectors, not just in the oil and gas and mining sectors. People have taken those jobs of their own free will, even though the jobs may not measure up to the compensation levels everyone would like. And yet Texas, like all states, is subject to the same monetary policy as all the rest: We have the same interest rates and access to capital as the residents of any of the other 49 states, for the Federal Reserve conducts monetary policy and regulates financial institutions under its purview for the nation at large. From this, I draw the conclusion that private sector capital and jobs will go to where taxes and spending and regulatory policy are most conducive to growth.” [Emphasis added]

Fulcrum Inquiry performs economic analysis and damages calculations in litigation, and business appraisals.