Everything on this web site begins with this philosophy:
*The measure of an economy is money.
*A large
economy needs a larger supply of money than does a small
economy.
*Therefore, a growing economy needs a growing supply of money.
*All money is a form of debt.
*Therefore, a growing economy requires a growing supply of debt.
*U. S. Federal Debt is the safest, most controllable form of debt. The federal government, alone among borrowers, never will default.
*Thus, there is no
federal debt or deficit problem, and a
balanced federal budget leads to a
recession or a depression.
The Interest Rate Fallacy
The Fed raises interest rates to fight inflation. To fight recession, the Fed does the opposite. It cuts interest rates.
This may sounds logical except for one, very small detail. The opposite of inflation is not recession; it’s deflation. So doing the opposite of what you would do to counter inflation makes no sense when trying to counter a recession.
We could have a recession with deflation. We could have a recession with inflation, which is called "stagflation." The history of Fed rate cuts, as a way to stimulate the economy, is not a good one. The Fed, under Chairman Greenspan, instituted numerous rate cuts. The result: A recession that President Bush’s tax cuts cured.
The Fed, under Chairman Bernanke, has instituted numerous rate cuts. The result: Today’s (2008) recession.
Why does common knowledge hold that cutting interest rates stimulates the economy? Because common knowledge views only one side of the equation. For every dollar borrowed there is a dollar lent. $B = $L. That much is trivial.
Cutting interest rates does cost borrowers less. So, the theory is, a business needing $100 million would be more likely to borrow if interest rates are low than when they are high. Further, consumers are more likely to spend when borrowing is less costly. So making borrowing less costly stimulates business growth and consumer buying. At least, that is the theory.
What seems to be ignored is the lending side of the equation. When interest rates are low, lenders receive less money. And who are the lenders? Businesses and consumers.
You are a lender when you buy a CD or a bond, or put money into your savings account. When interest rates are low, you receive less money, which means you have less money to spend on goods and service -- which means less stimulus for the economy.
In short, interest rates flow through the economy, with some people and businesses paying and some receiving. Domestically, it's a zero-sum game.
A growing economy requires a growing supply of money. Cutting interest rates does not add money to the economy. That is why there is no historical correlation between interest rates and economic growth. During periods of high rates, GDP growth is not inhibited. During periods of low rates, GDP growth is not stimulated.
Please review the following graph:
Not only are low interest rates not associated with high economic growth, but to a slight degree the opposite seems to be true. There seems to be a small correlation between high interest rates and high GDP growth. How can this be?
When interest rates are high, the federal government pays more interest on T-securities, which pumps more money into the economy. This additional money stimulates the economy.
This shows why the Fed's repeated rate cuts do not seem to stimulate the economy. The action is counter-productive. Cutting interest rates to stimulate the economy is like giving water to a drowning man.
