Moving Beyond Interest Rates for a Renewed Economy
In the past when our economy needed a jump-start, the method of choice was interest rates. The Federal Reserve Bank (Fed) would step in and ratchet down interest rates. After several downward rate adjustments, we would reach a rate that would give the business community sufficient confidence to believe that the return on investment (ROI) would be higher than the cost of debt from borrowing capital.
This conviction resulted in businesses borrowing money, expanding their operations, and increasing employment, as well as higher consumer confidence and more consumer spending. The effect of these events was that the economy bottomed out and went on to better times. See Figure #1.
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Without robust consumer spending, the direction of our economy will go from stagnant to receding. Consumer spending represents more than 70% of our economy. It is the key to our economy. Consumers’ motivation to spend their money depends on the level and direction of their confidence. There is only one way to improve consumer confidence, and that is to put people to work. Increasing employment is the surest way to increase consumers’ confidence.
Lowering interest rates doesn’t always bring an immediate result. Sometimes it takes a little longer. What happens when interest rates are lowered, and after a reasonable period of time businesses don’t expand, employment doesn’t increase, consumers’ confidence doesn’t go up, and consumers don’t spend more money? Worse yet, what happens if the balance sheets of lenders and borrowers deteriorate to the point where lenders don’t lend? See Figure #2.
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The problem of balance sheet deterioration is further exasperated by a Consumer Confidence Index chronicling record lows. This was validated on December 10, 2008 when investors accepted a zero percent rate in the government’s auction of $30 billion worth of short-term securities that mature in four weeks. Demand was so great even for no return that the government could have sold four times as much. In fact, for a brief moment, investors were willing to take a small loss for holding another ultra-safe security, the already-issued three-month Treasury bill.
