Wall Street and Trump have been pushing the fed for rate cuts for a while now. It looks like soon that they will have their wish come true. Now, if they could only get their spouses to follow their directions, they would be happy as a "pig in the mud"! Good luck with that.
Unfortunately, when rates drop down so low, it vastly reduces the feds ability to effect economic activity. As they say, it will be like "pushing on a string". That was why the fed took such unique approach to monetary policy in the "great recession". The low interest rates were the beginning of quantitative easing or QE.
For those unfamiliar with QE, the fed could not lower interest rates further because they were already at rock bottom. So, the fed bought bonds back. As the fed buys bonds back, they infuse cash into the economy. The bond seller gets the cash and the fed gets the bond. This caused the fed balance sheet to balloon up because the fed owned a gigantic number of bonds.
The fed gets their cash to buy bonds by “printing money”. In essence, the feds funds are manufactured out of the clear blue sky. My mom always told me that cash doesn't grow on trees, but the as I got older, I realized that the fed does have "dollar trees"!
After the fed stopped buying bonds back after several rounds of QE'ing, their focus turned to deleveraging their balance sheet by selling the bonds back into the market. This activity reduces cash in the economy as buyers pay the fed cash for the bonds. The push by many to vastly slow down the deleveraging activities of the fed caused the program to grind to a halt. Therefore, the fed is still over significantly leveraged.
The deleveraging of the fed would tend to slow economic activity and this is why the fed was moving so slowly in deleveraging. It is a very delicate balance between giving the economy enough lubricant (cash) and starving the economy. On the other hand, a highly leveraged fed could have negative effects on the US Dollar.
The US left the gold standard in the early 1970’s. The gold standard meant that each dollar printed was backed up by holdings of gold. After the gold standard was terminated, the dollar floated in value primarily based upon confidence in the US’s ability as an economic engine. To buy back bonds in QE, the fed had to print money, but too much printing of fiat dollars, can have negative repercussions on the “perceived” value of the dollar.
Now QE was a unique solution to keep the economy from sliding into a depression. It was done because the traditional tool the fed used was lowering the fed funds rate and the fed funds rate were at rock bottom. Now if the fed lowers the interest rates back down to zero while they are still leveraged, there will be few tools left at the feds disposal to buttress economic activity.
Japan and Europe are still paying low or negative rates that were driven by the events of the great recession - 10 years later! Their economies are still in a funk and aren't seeing any light at the end of the tunnel.
One thing people learn about history is that people don't learn from history. I sure hope we are not “painting ourselves into a corner”.
