Whatever the Fed chooses to do, it’s already failed..
Wile E. Coyote has gotten a bad rap: in all fairness, his schemes are ingenious, if overly complicated, and it’s not his fault that the Acme detonator misfires or the Road Runner doesn’t respond as predicted. Every set-up to nail the Road Runner shouldwork. That it fails and leaves him suspended over the cliff for a woefully brief second to intuit his impending doom really isn’t his fault.
Wile E. Coyote and the Federal Reserve share a lot of similarities. Just as Wile is always trying to catch the Road Runner, the Federal Reserve and other central banks have been trying for 10 years to trigger a self-sustaining economic expansion, i.e. an expansion based on the self-reinforcing dynamics of increasing productivity driving increasing wages which then fuel consumption and investment in productivity, and so on.
In a self-sustaining expansion based on fundamentals, central banks can “normalize” (raise) interest rates relatively painlessly to levels that are at least 3% above official inflation, so pension funds and other institutions that need low-risk yields can survive.
Official inflation in the U.S. is about 3% (real-world inflation is running between 8% and 13% in urban America, as per the Chapwood Index, but that’s another essay), so the Fed Funds Rate should be at 6% minimum, which would set mortgages and other long-term loans at 7% or so.
A Fed Funds Rate of 6% (600 basis points) would give the Fed 500 basis points of leeway in a recession to lower rates to 1% to goose borrowing, investing and spending in a recession.
But all the central banks’ intricate plans have failed, and so they are having a Wile E. Coyote moment of impending doom. The Acme Brand detonator they counted on– negative interest rates–has failed to spark a self-sustaining expansion, and all the Fed’s convoluted schemes–Operation Twist, buying a trillion dollars in sketchy home mortgages, etc.–failed to catch the prize.
And so the Fed was only able to raise rates, more or less at the last minute, by 2%— a pathetic admission that even after a decade of central bank-dependent expansion, the Fed couldn’t even raise rates into positive territory, i.e. above the official rate of inflation.
While the other central banks are falling into the abyss, the Fed is clinging to the edge of the cliff by its fingertips. Having failed to spark a self-sustaining expansion, now the Fed is left with two dismal choices: either let go and fall into the abyss of negative interest rates–doing more of what’s failed miserably–or cling on and keep rates at 2% so there’s some policy response left when the global recession inevitably washes up on America’s shores.
Whatever the Fed chooses to do, it’s already failed. The Road Runner of self-sustaining expansion got clean away, and the Fed is left holding the ominously ticking Acme Brand detonator.