Zero Interest Rate Policy (ZIRP) is failing for the reasons outlined below.
At least before ZIRP was just failing generally. Now we appear however to be feeling the first acute effects of this grand experiment. And that is not good news.
To turn things around, or at least to begin turning things around, rates have to normalize. Which means likely that rates need to go up.
President Obama’s “new norm” economy–slow, government-controlled growth dominated by the Fed’s giant system of allocating credit to the rich–should be a major focus of the economic and political debate. It’s become clear why near-zero rates don’t work. The policy creates a zero-sum game in which more credit goes to the most creditworthy–the government and the well-to-do–but less goes to others. Regulatory policy is limiting leverage, risk-taking and total credit, so the zero-rate policy causes a rationing process that misallocates credit and ends up hurting minorities.
The Fed has never really tried to explain this any differently. It doesn’t say it’s printing money, adding credit or leveling a playing field that’s been tilted toward Wall Street. It counsels patience, promises a trickle-down of wealth and jobs and parrots the annual assurances of big-government economists that the policy will work better next year.
The Fed says low interest rates encourage borrowing, which is true for those who qualify for near-zero-rate loans. But it discourages lending, which goes down when rates are too low. The supply and demand curves for credit are crossing at a low quantity of credit, with job creators getting less. Total private-sector credit is growing at less than 4%, with a lot of it going to rich bond issuers.
The Fed’s second major “stimulus” policy, buying and holding huge quantities of long-term government bonds, works the same way as near-zero rates. It helps a narrow, elite group of bond issuers, but with total credit limited by regulation, the bond issuance comes at the expense of broader growth and jobs.