Short-term rate of 0% is just a beginning

December 17, 2008|By JAY HANCOCK | JAY HANCOCK,

Fed Chairman Ben Bernanke once famously promised - half-seriously - to drop cash from helicopters if the economy got too bad.

With yesterday's decision to cut the short-term cost of borrowed money to nearly zero, one would think he has almost accomplished this. One would be wrong.

You can lead a banker to cheap money, but you can't make him ink a loan.

Banks aren't lending in enough volume to pull the economy out of its slump. Until they do, the price of short-term credit is largely irrelevant. My dealer might say the price of a new Porsche 911 is $37.99, but it doesn't do me much good until he hands over the keys.

That's why the helicopters are only warming up. Having exhausted its usual tools, the Fed is looking for new ways to get money to businesses and, especially, to consumers.

It is opening a new source of funds for credit-card companies, auto lenders and other providers of consumer credit. Last month's Fed decision to buy mortgages lowered the rate on a 30-year home loan by nearly a percentage point.

That's the Fed's new playing field - long-term rates.

Yesterday's lowering of the federal funds "target" rate to between 0 percent (it seems weird to type that) and 0.25 percent was really more of a commentary on the state of affairs than a serious policy move.

The rate is the price of overnight lending between banks. It was already less than 0.25 percent, making yesterday's record-low target doubly cosmetic. Banks aren't even lending much to each other, let alone clients.

But the Fed went out of its way to show that it's not out of ammo.

It will employ "all available tools" to restart the economy, it said. It will keep the funds rate at virtually zero "for some time." It might expand the mortgage-buying program. And it might even try to further influence long-term rates by buying Treasury securities with longer maturities.

The Fed's own research furnished much of the impetus for its unprecedented action. In a report last week, it disclosed that U.S. total consumer debt shrank last summer. That has not happened, even in severe recessions, since the central bank started keeping track in 1952.

No doubt much of the decline was mortgage debt that was declared worthless. But part had to do with credit-worthy borrowers who have cut back on their debt or are unable to borrow, analysts say.

In the U.S. economy, where consumers account for 70 percent of the activity, such a retraction is especially painful.

Scraping the interest rate barrel inevitably brings mention of Japan. Trying to recover from its own - even more spectacular - bubble, Japan held rates near zero for much of the 1990s. That did little to revive the economy. Today, Japanese stocks are still worth less than a fourth of their level when they peaked in 1989.

Fortunately, we're not Japan. Even more fortunately, Japan taught some lessons on how not to proceed. Bernanke and other policymakers appear to have learned them.

One lesson: move quickly. Japan took years to respond to its problems. But the main message is that traditional central-bank policy is only the beginning of what governments must do when bankers pull back lending.

Long-term rates are important, too. So are huge government spending programs to stimulate demand and complete necessary projects.

Only enormous World War II budgets brought the U.S. out of the depression that began in the 1930s. Japan eventually tried government spending as a jump-start, but many economists believe it was too little.

The United States, by contrast, is approaching the crisis with typical American overkill. The estimated size of President-elect Barack Obama's stimulus package has now headed past $500 billion. Between them, the Treasury Department and the Fed are doling out trillions in corporate bailout money.

Zero interest rates are only the beginning. We might eventually even get helicopters.

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