Richard Fisher: Federal Reserve's Low Interest Rate Pledge Misses The Point

NEW YORK -- As the Federal Reserve attempts to stimulate the economy and avert a new recession, one of the central bank's most basic tools isn't working, a top Fed official said in a speech Wednesday.

The Fed promised last week to hold interest rates at rock bottom for the next two years to keep money cheap and encourage Americans to borrow. But that's missing the point, said Richard Fisher, president of the Federal Reserve Bank of Dallas, who described a problem that many economists say is at the core of the nation's economic troubles. Namely, companies are sitting on cash instead of using it to hire workers and expand their business.

"You might now say to yourself, 'I understand from the Federal Reserve that I don’t have to worry about the cost of borrowing for another two years,'" Fisher said, according to his prepared remarks. "'What incentive do I have to invest and expand now? Why shouldn’t I wait until the sky is clear?'"

In its statement last week, the Fed acknowledged what many economists already knew: Risks seem only to be mounting, as the economy at home weakens and a growing debt crisis in Europe threatens to send shock waves through the global financial system. Prominent economic forecasters have been saying this month that the economy could slip back into a recession.

Given these fears, the Fed attempted to reassure Americans that it is working to promote a recovery. Fisher, who has long maintained that low interest rates can be counterproductive, was one of the dissenters to the central bank's statement.

The statement itself is supposed to act as an economic stimulus tool. Indeed, with other stimulus measures scant, the Fed's psychological guidance has become an important weapon in its arsenal.

But a chorus of experts says the message the Fed is sending isn't what the economy most needs to hear. Cheap money won't help, these experts say. Businesses already have plenty of it.

Non-financial corporations are sitting on a record $1.9 trillion in cash and other liquid assets, according to Federal Reserve data. The ratio of these businesses' liquid assets to their short-term liabilities is the highest it's been since 1956.

Some suggest that the American economy is now in a so-called liquidity trap, meaning that so much cheap money is lying around unused that lower interest rates will spur no further economic activity -- because the real problem is weak demand for goods and services. This condition has been at the center of the stagnation that has plagued Japan since its real estate bubble burst in the 1990s.

"The problem is the money is just piling up," said economist Bruce Bartlett, who was a senior policy analyst in the Reagan administration and an economist with the Treasury Department during the first Bush administration.

"When you're in a liquidity trap, nothing does any good," he continued. "At least in theory, you could increase the money supply -- you could double it -- and it wouldn't do any good at all."

Federal Reserve Chairman Ben Bernanke has emphasized that the Fed has the ability to prop up the economy if need be. The central bank completed a $600 billion stimulus program in June, in which it purchased Treasury debt to bid up the prices of those securities and lower interest rates. It has been re-investing in Treasuries as that debt has matured in an attempt to maintain that stimulus.

During a speech on Monday, Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta, said the Fed is "not out of bullets."

"I still maintain that a resumption of growth is the most likely case," Lockhart said. "But if that assessment proves to be wrong, I believe we do have tools to address whatever circumstances arise."

But monetary policy isn't sufficient, Fisher said. The Dallas Fed president outlined an argument he has made in the past that the Fed alone can't save the economy. Congress must also play a part, he said.

"I believe what is restraining our economy is not monetary policy but fiscal misfeasance in Washington," Fisher said in his Wednesday speech.

He said the recent debt ceiling debate in Washington has helped produce a widespread anxiety, which itself can harm economic activity. Consumer sentiment in August fell to its lowest level in more than 30 years.

Others say the federal government should directly boost demand by spending money.

"I don't think there's any question that an aggressive fiscal policy would be the most desirable thing at this point," Bartlett said.

Still, the Fed's guidance can tend to have a beneficial effect -- at least in financial markets. Stocks began an uneven ascent after the Fed's statement last week, after weeks of punishing declines.

The Dow Jones Industrial Average closed Wednesday more than 5 percent higher than last Monday, the day before the Fed issued its statement. Fisher cautioned that by pledging to keep rates low, the Fed could be seen as bailing out stock traders. It's an implication that could encourage excessive risk-taking.

"What Bernanke has tried to do has been grand actions that have a psychological impact," said Ernest Patrikis, a former general counsel at the New York Federal Reserve, and now a partner at the law firm White & Case. "I find that he has a calming and soothing effect, the nature of his personality."

"That's what we're not getting in the president," Patrikis continued. "Why did the president meet last week with Bernanke? He's maybe hoping some of it would rub off."

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