The economy seems to be recovering. Housing appears to have found a bottom. Unemployment is gradually improving. And America seems impervious to the trials and tribulations dogging the rest of the world. The Federal Reserve, with its policy of extremely easy money, would seem to have administered exactly the right tonic at the right time. Or has it?
A closer look at the reality of our economy tells a slightly different story. While the economy as a whole has improved, 2 percent GDP growth is well below what is needed to right the ship. More importantly, certain sectors have not been as resilient.
The automobile industry is still trying to get its groove back. Manufacturing, while improved from the lows of 2009, is well below its pre-crisis levels. Retail of all kinds continues to suffer as more and more Americans leave the workforce. And the one sector that is having one of its best years, finance, is seeing shrinking hours, lower pay, less benefits and more part-time workers.
Everyone is worried about their future. Even government employees can’t be sure they’ll have a job tomorrow. So what’s happened to all the money the Federal Reserve printed?
Quantitative easing is a fancy way of saying “putting money into the banking system.” To understand why it is not working, you have to understand what QE is supposed to do. The Federal Reserve Bank was created by Congress and charged with maintaining price stability and full employment via a number of available tools. The tool most often used is the Fed Funds rate, the rate banks charge each other to lend overnight to offset any deficit they may have in capital.
Here’s how it works: Bank A lends out too much money or has a few-too-many withdrawals on a given day. When it calculates its reserves, it realizes it’s a little short. Bank A can then go borrow money from Bank B, who had excess reserves to meet the shortfall. The rate at which loan is made is the Fed Funds rate.
As this terribly over-simplified example makes clear, if borrowing rates are very low, as they are now, banks should be borrowing lots from each other and using it to make loans. Unfortunately, that’s not the case. Remember, Bank B needs excess reserves to lend for the rate to matter. The crisis of 2008 was all about the banks not having enough to lend anyone. That’s why they had to be bailed out.
Lower rates also have an effect on consumers, who are encouraged to borrow money by the Fed’s effectively zero-interest rates. Again, things aren’t working out quite the way Chairman Ben S. Bernanke had hoped. A large number of consumers are either unqualified to borrow or have no desire to take on any more debt. The result is that the conditions necessary for an economy to run under its own steam are not present.
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