As an amateur economist (I got a C in econ 101, for the record), my understanding of the complexities of fiscal policy and macroeconomics is limited. The way I've been able to understand the role of the Federal Reserve is that they decide the price of money through controlling the interest rates on borrowing and lending US dollars. This is the only real lever we permit our government have on the economy, having learned from the Great Depression that price and wage controls distort market signals, and create value where there is no product, jobs where there is no work to do.
As far as I can tell, the same is true of raising and lowering the interest rate. Low interest rates made credit easy to come by, so people (myself included) borrowed lots of money. People borrowed for bigger houses, borrowed from those houses, borrowed for bigger cars, borrowed for vacations. And no one made any more money. Companies borrowed to leverage growth in their offerings based on the flood of money into potential consumers' pockets. But no one was making anything.
In my opinion, we shouldn't place controls on the price of things, but we should think about creative incentives and disincentives.
The US auto industry and manufacturing is clearly on the decline. Our extra money has us importing everything from Asia, rather than making it here, and we sell them less than we buy. Competitors are eating away at our comparative advantage for nearly all of the goods and services we're known for. And our economy's heath is dependent on everyone spending more than they make.
Since spending more than you make requires borrowing, we all clamor for cheap money, that is, low interest rates. Until people actually start creating value that someone else is willing to buy, we'll need cheap credit to keep to engine turning over. Cheap money can dampen the effects of recession, but in recent years, it hasn't found a new role for us as producers of valuable stuff in the global economy. It's the economic equivalent of prolonging a cold by taking DayQuil for a week straight.
So there's the fundamental problem with today's economy, and the reason why I think we're headed towards a nasty recession. Cheap money encourages spending, but does not create value on its own. Value requires both opportunity and brains. We all can't all expect to buy a house and make 10 percent a year without doing anything. That's not production, and it is quickly and necessarily eroded by arbitrage.
If houses increase in value by 10 percent a year, pretty soon, no one except for those with houses will be able to afford houses. Investments must be based on perceived value, not on speculation.
Injections of capital in the economy need to happen, but on a more thoughtful basis. The market doesn't just figure it out on its own. If we're going to control the levers of growth through a flat interest rate, how about monkeying with the rates for different types of borrowing. If the problem is on the demand side, make consumer borrowing easier. If supply is the issue, target specific industries or economic sectors with cheap loans. If housing is overheating, cool off housing and leave the rest alone. Why the hell not?
We're already interrupting the natural flow of the market by deciding what's the minimum interest banks can charge. Why not actually get some control over what happens?
