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Peter Crabb: Fed’s fiddling with monetary policy barely nudges supply

After their most recent meeting, the Federal Open Market Committee announced the end of the long-term United States Government bonds buying program affectionately known as QEII.

The Fed said it will, however, continue to keep its target Fed funds rate at the historically low range of 0 percent to 0.25 percent.

More than two years past the financial crisis the “string” of low interest rates and long-term bond buying has done little to spur investment and economic growth.

Interest rates on short-term U.S. Treasury bills remain near zero and longer-term borrowing rates for businesses and homeowners are well below their historical averages.

In normal economic times lower bank rates create strong incentives for borrowing, investment and consumption.

Obviously, these are not normal times and monetary policy is ineffective.

Excessive fiscal spending has weakened the Fed’salready-imperfect influence on the economy.

The Fed has historically had three tools to affect bank lending and economic activity: open market operations, reserve requirements and the discount rate. Only the first of these three was ever used regularly.

The cash banks are asked to keep on hand, required reserves, changes infrequently and the rate banks are charged for borrowing directly from the Fed, the discount rate, is largely irrelevant because banks don’t like to use this option.

Only open-market operations — the purchase and sale of bonds in the inter-bank lending market — are regularly used to conduct monetary policy.

Since the financial crisis, the Fed has added to its tool box — buying for itself long-term Treasury bonds and government-backed mortgage bonds and paying banks interest on reserves.

However, the Fed still can’t force banks to lend.

No matter what new ideas they come up with monetary policy will always be an imperfect tool.

The Fed can affect what is called the monetary base, but this may or may not change the money supply.

The money supply is what banks are willing to offer to others at various interest rates. A graph would show the quantity of money banks are offering for use in the economy at any given interest rate. Conversely, the base is what banks have available to offer at any particular point in time.

With open-market operations and direct bond purchases the Fed has rapidly increased the base but had little effect on the money supply.

Since 2008, the monetary base has grown threefold while conventional measures of the money supply are up only 16 percent.

There is a lot of money available; it’s just not being used. Why?

Fiscal policy is crowding out the Fed. When the federal government runs continuing deficits and borrows more, capital flows to these safe investments at the expense of private investment.

An improved fiscal position will give the economy the confidence it needs.

Increases in private investment occur when business owners and managers have confidence they can earn decent returns. The Fed can’t build confidence pushing on a string weakened by poor fiscal policy.

PETER CRABB Professor of finance and economics at Northwest Nazarene University in Nampa

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