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The measure of an economy is money. A large
economy needs a larger supply of money than does a small
economy. Therefore, a growing economy needs a growing supply of money. All money is a form of debt. Therefore, a growing
economy requires a growing supply of debt.
U. S. Federal Debt is the safest, most controllable form of debt. The federal government, alone among borrowers, never will default. Thus, there is no
federal debt or deficit problem, and a
balanced federal budget leads to a
recession or a depression.
The Fed raises
the Fed does the opposite. It cuts
interest rates. This may sounds logical except for one, very small detail. The opposite of
is not recession. The opposite of
is deflation. So doing the opposite of what you would do to counter
makes no sense when trying to counter a
recession. We could have a recession with deflation. We could have a recession with
which is called "stagflation." The history of Fed rate cuts, as a way to stimulate the economy, is not a good one. The Fed, under Chairman Greenspan, instituted numerous rate cuts. The result: A
that President Bush's tax cuts cured.
The Fed, under Chairman Bernanke, instituted numerous rate cuts. The result: The 2008 recession.
Why does popular wisdom hold that cutting
stimulates the economy? Because popular wisdom views only one side of the equation. For each dollar borrowed a dollar is lent. $B = $L. That much is trivial.
does cost borrowers less. So, the theory is, a business needing $100 million would be more likely to borrow if
are low than when they are high. Further, consumers are more likely to spend when borrowing is less costly. So making borrowing less costly stimulates business growth and consumer buying. At least, that is the theory.
What seems to be ignored is the lending side of the equation. When
are low, lenders receive less money. And who are the lenders? Businesses and consumers.
You are a lender when you buy a CD or a bond, or put money into your savings account. When
are low, you receive less money, which means you have less money to spend on goods and service -- which means less stimulus for the economy.
flow through the economy, with some people and businesses paying and some receiving. Domestically, it's a zero-sum game.
A growing economy requires a growing supply of money. Cutting interest rates does not add money to the economy. That is why there is no historical correlation between interest rates and economic growth. During periods of high rates, GDP growth is not inhibited. During periods of low rates, GDP growth is not stimulated.
Please review the following graph:
Not only are low
not associated with high economic growth, but to a slight degree the opposite seems to be true. There seems to be a small correlation between high interest rates
and high GDP growth. How can this be?
are high, the federal government pays more interest on T-securities, which pumps more
into the economy. This additional
stimulates the economy.
This shows why the Fed's repeated rate cuts do not seem to stimulate the economy. The action has been shown, time and again, to be counter-productive. Cutting interest rates to stimulate the economy is like pouring water on a drowning man.
Do you remember these headlines: "Employers slashed 80,000 jobs in March." "The U.S. central bank has lowered
by 3 percentage points since mid-September" "The loss of jobs signals another interest
cut by the Federal Reserve later this month." "Federal Reserve Chairman Ben Bernanke acknowledged Wednesday that the country could be heading toward a
recession, saying federal policymakers are 'fighting against the wind' in combating it."
Rate cut after
rate cut has done nothing. So what is the Fed's plan? Another
rate cut. During the previous
the Fed also attempted
rate cut after
rate cut, to no avail. The
recession, finally ended with the Bush
tax cuts. The Fed has not learned from experience, but stubbornly adheres to the popular wisdom that interest
rate cuts stimulate the economy.
Rate cuts do not stimulate the economy. They never have. They never will.
"Stimulating" an economy means making it larger. A large economy requires more money than does a smaller economy. Therefore, the only thing that stimulates the economy is the addition of money.
Rate cuts, by reducing the amount of interest the federal government pays, actually reduce the supply of money. We are on the edge of a
recession, because the economy is starved for money. The coming "stimulus" checks will help, but they are too little and too late. This should have been done months ago, and the amounts should be far larger.
The only way to prevent or cure a
recession: Federal deficit spending. There is no excuse for
These problems are not
economic failures. They are leadership failures.
FREE MONEY tells what our leaders should do to prevent and cure stagflation.