October 1, 2011

The Transparency of the Fed

A common understanding of the economic term inflation is that it is synonymous with a general rise in prices. Closely associated with inflation is the notion of low interest rates. On the Federal Reserve’s website the reader is given the chance to experience a concise and highly ineffective argument for the economy-restoring quality of these low interest rates. According to the website it is important to keep interest rates low when the economy is having trouble. Second, the Federal Reserve should purchase ‘high-quality securities’ to keep long term interest rates low as well. This helps people finance new spending and keeps prices steady. It is the Federal Reserve’s goal to have high employment and prices steady. According to their website, having low interest rates has helped the economy’s situation. The situation could be better. The website informs its reader that the Fed will therefore continue to keep interest rates low.
“Some people mistake this illusory prosperity [early inflation, when people feel richer and spend more than they normally would] for real growth and recommend constant inflation as a means to continuing prosperity. They call their policy “low interest rates.” Since, when the Fed sets rates artificially low, it must increase the money supply to keep them low, it comes to the same thing. But inflation cannot really make society as a whole wealthier. Every transaction that is an income for person A is an expense for person B. If we try to use a rise in prices to universally boost incomes, we must, simply by definition, also universally (and to the same extent) boost expenses.”
This is a quote by Callahan in his book called Economics for Real People. Now consider another quote from a different source, an internet article on CNNMoney. After discussing some of the Federal Bank’s recent actions and relating some different opinions prominent economists have regarding the Fed’s behavior, the author ends with:
“All those policies are geared toward a common goal: reduce interest rates even further than their current historic lows, thereby making borrowing cheaper for businesses, consumers and homebuyers.”
I am probably more likely to borrow $10,000 at a low interest rate than I would be if the interest rate was high. I am also likely to spend that $10,000. If it is the case that an aggregate increase in dollars spent is an increase in aggregate prosperity, then by providing easier access to loans the Federal Reserve has in fact increased prosperity (i.e. productivity or increased standard of living). Unfortunately, a result of increasing the money supply through low interest rates/inflation is higher prices. The purchasing power of money remains the same and there has been no real economic growth. What I found most interesting in the article was that while people disagreed about whether or not the Fed should let the public know that it plans on keeping its interest rates low, no one questioned the initial premise; that low interest rates will increase general prosperity.

1 comment:

Courtney Camelin said...

Soooo what is your opinion....closed Fed or open Fed?