Monday, April 25, 2011

A Question for the Chairman: Is the Fed Doing Its Part to Reduce the Federal Deficit?

This week, Chairman Ben Bernanke of the Federal Reserve holds the first ever press conference by a Fed Chairman. The wisdom of opening himself up to volleys of dumb, loaded, and unfair questions isn't crystal clear. Since, however, he's voluntarily decided to position the seat of his pants in the middle of a firing range, here's a question that should be posed to him.

It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?

The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.

The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).

For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.

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