The Federal Reserve is giving money away. Statement here. Excerpts:
"The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.
"Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.
"Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters...
"The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level..."
“They’re running themselves out of room," says Ted Peters, chairman of Bryn Mawr Trust Company and a new appointee to the board of the Fed's Philadelphia branch. "You put yourself in a corner a little bit. But the concern right now clearly is deflation, and the economy spiraling downward. I’m concerned we’re throwing a lot of money at the problem. Are we creating a debt situation we’re not going to be out of?”
Bank analyst Richard X. Bove, at Ladenberg Thalmann, says we're in what liberal economists call "a liquidity trap." That's what happens "when nominal interest rates are close to zero and increases in money supply have no impact on the economy.
"The problem arises because holders of funds refuse to use them, preferring to hoard instead... They have made the collective decision that it makes more sense to hold money at zero rates because they believe that purchase of assets of any type will lead to losses. They may also believe that deflation is upon us in which case money grows in value even if the interest rate is zero..."
"The interest rate and monetary stimulus being afforded to the economy is having no effect at present and this would be a perfect liquidity trap – i.e., no one wants to spend or take risk.
"There are two ways out of a liquidity trap. The first is to stimulate inflation. If holders of funds believe that money is dropping in value they are likely to get rid of it by purchasing “things”. This stimulates growth.Second, is to have fiscal policy become very aggressive. In this case, the government spends the money built up in the system putting it to work in the economy.
"It looks to me that both courses are being pursued. So there is hope of recovery."
Posted: December 16, 2008 - 3:09 PM
Joseph N. DiStefano
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