There are two remarkable things about the Fed's decision today to cut interest rates to virtually zero. The first point is that it is bringing the US to Japan's zero interest rate policies. The second is that the Fed has now become the most important commercial bank in the US. In effect, it is taking over the US banking system. Read the Fed's statement and you see that it amounts to nationalization.
"The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant."
All this needs to be seen in the context of some of the worst fundamentals for any economy. Consider this: jobless claims have reached their highest level since the 1980s and some commentators believe US employment might reach as high as 10% in 2010, the destruction of wealth continues with US prices forecast to fall further until end-2010 or mid-2011, the US federal deficit could top $1 trillion if the US government used the same accounting methods as private companies and worries about inflation have been replaced by concerns about deflation.
The problem is that when things start recovering, the Fed will have created too much money. "Right now, the crisis is created by the huge demand by banks for hoarding cash. The Fed is providing cash, and the banks want to hoard it. When things start returning to normal, the banks will want to start lending it out. If that much money is left in the monetary base, it would be extremely inflationary," Princeton economics professor Alan Blinder told the New York Times.
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