Business Insider

Peter Crabb: Business confidence is vital to end the economic slump

The Fed has stopped pushing on the string. This week the Federal Open Market Committee voted unanimously to take its target fed funds rate down from 1 percent to a range of 0% to 0.25%.

The string of lower interest rates has yet failed to spur greater investment or consumption. With interest rates on U.S. Treasury bills already trading near zero, there is unlikely to be any economic impact of this rate.

If we were living in normal times, these lower rates would reduce the cost of borrowing for households and businesses, creating the incentive for more borrowing and purchasing — that is, more economic activity. Obviously, these are not normal times and economic policy is not what it used to be.

A big problem for the Fed governors is defining the money supply. When policymakers wish to use manipulation of the growth (or contraction) of the money stock as a tool of economic policy they first face the problem of what to measure.

The money supply is a line or curve showing the entire quantity of money offered to others at associated interest rates. This table or graph would show the quantities of money circulating within an economy for any given interest rates.

Conversely, the money stock is the total amount of money available in a particular economy at any one point in time. There are many things we can use for money, including currency and our debit cards.

There are two basic measures of the money stock – M1 and M2. M1 consists of circulating currency (which includes what banks hold in their vaults), traveler's checks, and all checking accounts. M2 consists of M1 plus all savings deposits and balances in non-IRA money market mutual funds.

During this crisis the Fed has been able to rapidly increase the money stock — increasing what is in these accounts and available to banks — but the quantity of money supplied to the market has not changed dramatically. There is a lot of money available; it is just not being used.

The quantity of the money stock has increased. The quantity of money supplied has not. Monetary policy has always been an imperfect economic tool.

Many of the Fed Governors are now saying they have done all they can, and it is now up to "massive" fiscal stimulus. That is, the Federal Reserve expects the initiation of a big federal government program designed to stimulate demand in the economy.

The economy needs more confidence regardless of whether it is found by the historically low interest rates the Fed has provided or a large dose of government spending. Policy that simply throws more fuel on the fire does little to change attitudes.

The economic funk we find ourselves in will not end until there is an increase in private investment. This occurs when businesses owners and managers have confidence they can make decent returns. Such confidence can only come from within.

Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.