The Fed Holds Its Fire—Out of Bullets?

By: Dr. Lynn Reaser

The Federal Reserve concluded its August meeting with a decision to do nothing.  Monetary policy officials acknowledged a slowing economy, still high unemployment, and subdued inflation.  The stock market was clearly disappointed.  Was the Fed correct in not doing “something?”

The answer would appear to be “yes” for two primary reasons.  First, the Fed’s ability to positively impact the economy is now very limited.  Monetary policymakers are running out of bullets and clearly have no golden ones left.  Interest rates are at record lows and the Fed has injected a massive dose of liquidity into the economy.  More Fed easing will not solve the problems of a severe lack of business confidence, difficulties in Europe, or fiscal gridlock in Washington.  Companies in most cases are not borrowing because they either do not see the justification from sales growth or remain too worried about various regulations, the potential for higher health care costs, or possible tax cuts.  For potential homebuyers, the problem is not the level of interest rates but rather the difficulty in qualifying for a loan.  Many consumers are not borrowing either because they do not have a job or are still focused on reducing debt burdens they have accumulated in the past.

Second, more Fed easing could do more harm than good.  Savers will be hurt the more interest rates fall and the longer they stay low.  If consumers and companies think interest rates will not rise any time soon, they will have little incentive to borrow and spend now.  Finally, there is a risk that super-easy monetary policy could be laying the ground for some future “bubble” or inflation down the road.

Sometimes no action is the best action.


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