Thursday, July 14, 2011

Getting zirpish (17 Dec 2008)

In the wake of the Fed's moves yesterday, the word of the day in the econoblogosphere today is ZIRP: zero interest rate policy. (This is also known as "quantitative easing" -- what happens when Fed rates can't be cut any further, but the Federal Reserve still wants to influence them in the wild.) In other words, the Fed has made its last rate cut. The technical terminology and wonkery involved here may make this seem like something ordinary people can safely ignore, but to judge by the reaction among Fed watchers, it's as though one of the four horseman of financial apocalypse has rode onto the scene.

By pushing the rates to zero, Fed Chairman Ben Bernanke is, in effect, making good on his suggestion in 2002 that central banks can drop money from helicopters in the event of deflation. Martin Wolf, in this FT editorial, puts a dark spin on this turn of events.
As Robert Mugabe has shown, anybody can run a printing press successfully. Once the interest rate hits zero, the Fed can perform much further easing. Indeed, it can create money without limit. Imagine what would happen if an alchemist could transform lead into gold, at no cost. Gold would not be worth much. Central banks can create infinite quantities of money, at no cost. So they can reduce its value to nothing without difficulty. Curing deflation is child’s play in a “fiat money” – a man-made money – system.
The upshot: If we keep printing money, it eventually becomes worthless. Wolf doesn't predict Weimar-style hyperinflation for the U.S., but does expect acute inflation years down the road.

Whether or not ZIRP will work to get more money into the system and narrow credit spreads between Treasurys and commercial rates seems to be a matter of some debate thus far -- Yves Smith rounds up some opinions here, noting the disquieting air of desperation in the Fed's moves. Calculated Risk notes that money-market funds may be induced to give negative returns -- rather akin to the calamity that helped spark the mayhem in the wake of Lehman Brothers' collapse.

Basically, the Fed is done now with anything resembling the conventional monetary policy of the past few decades and is in terra incognita. We can only hope the atmosphere is hospitable.

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