The Definition of Insanity and the Fed

One of the definitions of “insanity” is to keep doing the same things over and over and expecting a different result.  The Federal Reserve Board has been keeping interest rates almost zero for more than 7 years now – longer than any other time in history.  They have reviewed this each quarter of every year and kept doing the same thing expecting the economy to start growing at a faster rate.  And it’s still not happening. Does that mean the Fed is insane?

I believe that the initial Government reaction to the 2007 financial crises was appropriate.  The government has always been responsible for the monetary system.  And stability of the system is crucial to the workings of the economy – both to individuals and to companies.  Both the bailouts and the lowering of interest rates were probably critical to softening the landing.  But once the economy has bottomed out, the government’s job is to restore the “normal environment” as soon as possible.  Near zero interest rates are not normal.  And for people to react “normally” the expectations of the environment must be normal.  We’re not there yet, and one of the reasons is likely the interest levels.

In today’s Wall Street Journal  there is an article on the Op Ed page by Daniel Yergin which makes the point that in the last few years we in the West have lost our faith in economic freedom and instead have now a “misguided” trust in government control.  He says why he thinks this has happened and why he thinks it causes problems.  I believe he could be right.  In the early 1920’s as Robert Samuelson pointed out in an editorial page piece a year or so ago, we had a downturn almost as bad as we had in 1930 but the recovery was complete within two years and the 1920’s became the “roaring 20’s”.  That was without any help from the government.  In the 1930’s the government intervened.  There are different opinions on how effective that was, but I believe it softened the landing – a good thing – but may have lengthened the recovery – a bad thing.  Keynes wrote his macro-economic theory in the late 1930’s – probably inspired by FDR’s “New Deal”.   By the end of WWII, the economy was back in growth mode, but in the 1960’s the economic guru’s had bought into Keynes theory and were given advisory roles in the Federal Government.  How well that worked out is probably still in debate, but in the 1970’s we had “stagflation” which was no fun.  Then as Yergin points out in the last two decades of the 20th Century we tended to recover our faith in a free market economy.  However, after the 2007 crises, we are back looking for the government to “save us”.  But that doesn’t seem to be working out too well.

Some where back in my youth I learned another saying, “The road to Hell is paved by good intentions”.  I used to believe that this meant, not following through with taking actions on what I knew I should do.  Then I learned about the “law of unintended consequences” which means doing something that is supposed to have good results, but has some unforeseen bad consequences.  I decided maybe that’s what the “road to Hell’ is paved with.  We may be trying to do the right thing with the best of intentions, but unless we think it though and are willing to try something different, bad and unforeseen thing happen that we did not intend.   Also in the Wall Street Journal today, there was a story about a lot of corporations having trouble with keeping employee pension plans funded because of low-interest rates.  Typically, defined benefit pension plans are funded with investment grade bonds so the principal is protected and the interest earned reduces the amount of money the company has to contribute to plans to have them fully funded.  Among other things the article said that General Motors Co. in February took on $2 billion in debt only to put all of it into its employee pension plans.  And they were not the only company specifically mentioned in the article that is having the same sort of trouble.  Money going into pension plans is money that is not being spent on new plant and equipment that creates additional jobs.  Who is benefiting from this?  It would appear to be the U.S. (government) Pension Benefit Guarantee Corporation which charges premiums to backstop private company pension plans.

That has to be an unintended consequence to the Fed’s interest rate policy.  I had not thought about this aspect until I read the paper today.  I had thought about the effect on the economy that results from the number of “baby boomers” retiring and the effect of low-interest rates on middle class retirees, and individuals trying to save for retirement and other things  But I had not thought about this.  The government giveth and the government taketh away.  This “drag” on the economy is probably something the Fed did not intend by keeping interest rates low.  But here it is.  Did they think about this?  Maybe not – at least in the beginning.  But here it is.  Will they keep doing what they are doing expecting something different?  Are they “insane”?  Or will they try something different?

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About tjc13

BE - Chem Engineering, Vanderbilt Univ, MBA, University of Tulsa - Worked for an energy and chemical company for many years and then started a management consulting business working for both for-profit and not-for-profit organizations.
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One Response to The Definition of Insanity and the Fed

  1. Thanks for this blog post regarding the Federal Reserve; I really enjoyed it and am definitely recommending this blog to my friends and family. I’m a 15 year old with a blog on finance and economics at shreysfinanceblog.com, and would really appreciate it if you could read and comment on some of my articles, and perhaps follow, reblog and share some of my posts on social media. Thanks again for this fantastic post.

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