The Dangers of the Current Monetary Policy Program
By Sasha Cekerevac for Investment Contrarians |
At the end of 2008, the financial crisis in America was so severe that the Federal Reserve began a historically significant and unprecedented monetary policy program, which has continued to this day, dramatically altering the financial and economic landscape.
Considering the extent and breadth of this huge monetary policy program by the Federal Reserve, two questions linger: why hasn’t the economy recovered as many economists had expected, and what is the downside?
Monetary policy is an extremely complicated initiative, with the end result not easily quantified or predictable. One of the most common complaints has been the lack of income from savers due to the lowered interest rates.
There is some validity that a massive amount of income has been foregone from savers because of these lower rates, due to easy monetary policy by the Federal Reserve and other central banks around the world.
According to The Economist, personal interest income has declined at an annual rate of $432 billion since 2008, more than four percent disposable income. This was interest income that was not generated and, ultimately, not spent in the economy. (Source: “Savers’ Lament,” The Economist, December 1, 2012, last accessed January 7, 2013.)
However, the situation is far more complex, as there are two sides to every coin. The lowered interest rates due to easy monetary policy by the Federal Reserve have also decreased the costs of borrowing.
The Bank of England conducted a study showing that between 2008 and 2012, the lowered interest rates ended up costing savers 70 billion pounds in lost income, but households saved 100 billion pounds in interest expense. (Source: The Economist, last accessed January 7, 2013.)
The difference was actually a cost to the banks, which cannot lower deposit rates any more to compensate for lower loan rates. There is a floor in monetary policy initiatives, and the Federal Reserve has appeared to have hit it, along with other central banks around the world.
One of the most confusing parts of this economy is that even though jobs growth has been lackluster, certain parts of the economy have been somewhat strong in 2012, namely housing, retail sales, and car sales.
Part of the reason for this is that lowered interest rates have helped the average consumer afford additional purchases through the monetary policy stimulus enacted by the Federal Reserve. Interest payments consume approximately 20% of middle-class income, versus only nine percent for the wealthiest one-tenth of families. As monetary policy has lowered rates, one positive action from the Federal Reserve has resulted in stronger retail sales and car sales from the middle class.
However, there is a danger to this monetary policy initiative by the Federal Reserve, and that consists of the unintended consequences.
For one example, pension funds allocate assets for their future retirees. Because of lowered interest rates, these pension funds have now become under-funded and are seeking higher yields, which are also riskier assets.
According to Mercer, American defined-benefit corporate pension plans could meet only 72% of future obligations, showing an approximate deficit of $619 billion. (Source: The Economist, last accessed January 7, 2013.)
While the Federal Reserve is trying to kick-start the economy, many investors are now being forced into riskier investments to try to obtain a decent return. This monetary policy initiative will end up resulting in far too many investors buying assets that are too risky for their portfolios.
This is what caused the financial crisis in the first place: a monetary policy from the Federal Reserve that was far too easy and resulted in investments that people should not have been taking in the first place. If these investments end up losing money, who’s going to bail them out?
The danger in trying to manage an economy, whether it is by the Federal Reserve or Washington, is that there are massive unintended consequences that could result. While monetary policy might have a positive short-term impact, the long-term costs are usually not known or properly calculated.
So while the average citizen has benefited in 2012 with a lower monthly interest payment, if their pension loses a significant amount of money, are we really any better off in the long term? This is just one simple question among hundreds, if not thousands, of variables regarding monetary policy by the Federal Reserve.
The real danger is easy monetary policy that is too stimulative for too long. Of course, the Federal Reserve can only do so much.
The ineptitude and inability on the part of Washington politicians to create real structural reforms that can create an atmosphere of pro-business incentives that will stimulate the growth potential for the U.S. economy are the real issues.
For too long Washington politicians have believed that they are the center of an economy. We need to get back to the truth: the only drivers for long-term economic growth are private businesses and the innovation that stems from entrepreneurs.