WHAT’S YOUR INTEREST IN INTEREST RATE CHANGES?

by Peter Bearse

So, the Fed has done it again – lowered interest rates. Should we be glad or sad?

The Federal Reserve Bank, or “Fed” as it’s affectionately called, is the controller of our nation’s monetary policy, a power it exercises by raising or lower the rates of interest on loans it provides to private banks. These inter-bank rates gradually filter down to affect bank loans system-wide, credit card rates and other rates of interest.

Why should the Fed want to lower interest rates as much as ¾%? After all, one of the major roles of monetary policy to keep inflation under control as well as stimulate the economy. Unfortunately, these goals are sometimes contradictory. A basic rule is that the number of tools you need to manage an economic system has to be at least equal to the number of different goals you’re trying to pursue. Monetary policy is not supposed or able to do the heavy lifting of macro (national) economic management all by itself. What about fiscal (tax) policy? Here again, there’s a contradiction. President Bush is constantly touting his tax cuts as keys to economic growth. But inflation is rising while economic growth is slowing. Our economy faces the danger of “stagflation” – of becoming a stagnant (no-growth) economy with inflation.

The Fed has been overreacting to events -- primarily the sharp downturn in the housing sector due to the sub-prime loan crisis. Many writers charged “bailout” favoring large investment firms who were stuck with large numbers of subprime mortgage securities in their portfolios. When interest rates go down, the price of debt securities go up, so firms trying to unload their blighted portfolios would suffer less losses. Consumers relying on credit cards to make purchases are also pleased. Those holding adjustable-rate mortgages get some help, too.

Widen the focus of your lens, however, and the likely impacts of the Fed’s rate cuts appear much less favorable. There’s the problem of what economists call “moral hazard” – providing incentives in the wrong direction if the cost of bad behavior is reduced. Many investors made poor decisions; many borrowers were careless. Why bail them out? To the extent that people do not suffer the consequences of bad choices, there’s an incentive for them to be made again. Market forces punish as well as reward.

We are living beyond our means. Why provide greater incentives for consumers to buy more on credit in the here and now when there’s such a huge overhang of debt, both private and public, threatening the future of the consumers’ children? Why give foreign lenders, especially China, whose purchases of our debt have helped to sustain our over-consumption, incentives to sell their bonds and/ or reduce their investment in our economy? Why make it harder for Toyota to build a new plant in the U.S.? Fed interest rate cuts smell of poor politics rather than good economic management.

The real issue is that our economy needs a major readjustment but “poor politics” is holding us back. We suffer from ad hoc-ism, short-term-it is, dumbing-down, closing-down, mistrust and institutional hardening-of-the-arteries. Yet, we live in a world rife with long-term problems that is changing at an accelerating rate driven by advances in science, technology, entrepreneurship and innovation. Our public institutions have failed to keep up. The Fed is only one example. But for encouraging people to “Go Shop,” how influential is its micro-management of the economy through interest rates when influence over the money supply has been shifting to private, non-bank sources of capital?

Meanwhile, the government mistrusts the American people and the people return the favor. As we approach a presidential election year, people again yearn for a change, but the hope placed on changing the President is misplaced. Change in Congress is the key to the future of a democratic Republic. What is supposed to be the people’s primary branch of government, the Congress, has been corrupted by an incestuous mix of big money and big media. It is backward and undemocratic. It has been undercut by overcentralization of the government and increasing power of the President. The American people, AWOL from politics, acting as if they could “Let George do it,” have suffered from governance of “the best and the brightest” over and over again. “When will we ever learn…”

Only 11% of voters approve of the job Congress has been doing. Over 70% outright dis-approve. Yet, most like their own Member of Congress. The disconnect is dangerous unless “their” Member was elected with both a vision and a program to change the institution. Change starts with the number one: One leader, one innovator, one entrepreneur and, yes, even one member of a body resistant to change. Has the Fed’s change in the interest rate exhausted your interest in change?

Peter Bearse, Ph.D., International Consulting Economist, 11/4/07, welcomes feed-back to peterj@politicalcommunity.us.