We now have a translation of the article for you from The Wall Street Journal, written by Gerald P. O'Driscoll, former vice president of the FED in Dallas, now an employee of the CATO Institute. What do low interest rates and state "consumption aid" lead to? Are they desirable at all?
The policy of low interest rates is a textbook example of central banks' responses to the economic downturn caused by insufficient aggregate demand. This policy is defended by the fact that money can in many ways support economic activity - for example, by the fact that low interest rates support investment, discourage savings, encourage increased consumption spending and allow individuals to refinance their existing debts with new ("cheaper") debts.
Although the effects of this theory seem reasonable, this "textbook policy" is napplies to our current situation.
First, the current ongoing crisis and economic downturn is not based on the Keynesian failure of purchasing power, but on Hayek cycle boom and crash.
Second, the textbooks in their examples consider the "low interest rate" strategy to be a cost-free method. But such a method does not in fact exist.
The cycle we were able to follow in the real estate industry was a classic example of an asset bubble that we could often follow, for example, in the 18th and 19th centuries. Cheap money provided through cheap loans has caused that long-term investment they seemed more valuable than they would have been in other situations.
Usually, the investment boom will hit industries with relatively solid fundamentals. But once money from cheap credit starts to flow, principles are forgotten and evolution will turn into "mania" (let's use this old-fashioned term now). The unsustainable will just collapseso the boom ends in a crisis.
If we want to prevent crises, we must be clear about the causes and the consequences. In this case, however, it is "Failure of purchasing power demand" as a consequence - not the cause - of the crash.
The decline in real estate prices after reaching their peak had an impact on the entire financial system, and through it on the rest of the economy. Toxic mortgages had a negative impact on the accounting of companies and institutions that bought them through the securities market. As we know, the prices of (not only) shares of these (mainly, but not only financial) institutions subsequently fell. Confidence has dried up and the economy has collapsed. General escape from stock markets naturally followed.
The panic in the financial markets and the ensuing strong recession were examples classic accounting crisis. Along with the negative development of balance sheets, demand collapsed. At the same time, a liquidity crisis emerged, which also helped the collapse of Lehman Brothers. But the main force of the crash was the collapse of the balance sheets, the decline in capital changes and for many also the subsequent insolvency.
The circumstances surrounding the decline in house prices, investor portfolios and 401 (k) plans also had a large impact (specific type of employee pension savings, translator's note) and the uncertainties surrounding the pension system.
The solution is trapped in the restoration of balance sheets. For financial companies, that means capital increase. For consumers and businesses, that means save more than their income has lost.
Nevertheless, politicians focus almost exclusively on supporting spending increases regardless why spending fell - with consumption at the forefront. We cannot sustain higher spending, unless the accounting balance of enterprises and households is restored.
Various emergency expenditures and temporary tax breaks are also in doubt, especially now that one is rationally led to more savings and less consumption. For example, various one-time tax breaks for households only cause shift consumption from the future. Such different fiscal programs rather they are working on another depressionthan to amplify future consumption.
Insufficient goods are not liquidity, but savings. The Fed, however can only provide the first one, not the other. Both fiscal and monetary authorities must focus elsewhere. The Fed has already more than adequately responded to liquidity problems. It's a little further in that, so it can look beneficial.
However, moving towards a quantitative easing of the Japanese cut is a mistake. And historically low interest rates - about which the Bank for International Settlements, the "central bank bank", issued a warning in its 2009/2010 annual report - will disrupt economic activity just like it did during the real estate boom. Low interest rates will slow down the process of restoring accounting equilibrium, as low interest rates keep asset prices at an artificial level. At the same time, low interest rates demotivate savings, which again prolongs the recovery process.
Taxes need to be reoriented from the current stimulus to consumption to support productivity investment. This does not mean an increase in income tax. Especially President Bush's "tax cuts" would should be maintained. Regardless of who is in charge of the administration, the abolition of Bush's tax breaks would mean a large increase in the marginal tax rate in the midst of an economic downturn. The result would be an increase in the cost of saving, making it more difficult to accumulate capital and discourage businesses from growing and hiring. Minister of Finance Tim Geithner is about to repeat Herbert Hoover's mistakewhich persuaded Congress to tax increase in 1932.
Markets can handle a lot, but bad political decisions can playfully disrupt the process of rebuilding them. Well, at present, both the fiscal and monetary policies are full of bad decisions.