Submitted by Taps Coogan on the 31st of July 2019 to The Sounding Line.
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Let’s assume that the Federal Reserve and other central banks cut interest rates and enact other stimulative polices in the coming days and months. Let’s assume that they succeed in extending this record long expansion for a while longer.
Three things are likely to happen. First, borrowing that would have been uneconomical at today’s already-very-low interest rates will accelerate. In other words, the weakest elements in the economy will become even more indebted. That will make normalizing policy even harder as an ever larger portion of the economy becomes reliant on low interest rates for its economic existence.
Second, low rates will continue to push risk asset prices higher, exacerbating the wealth divide in the country.
Third, unless you think that the current round of rate cuts will eliminate recessions for all eternity, we will wind up sliding into a recession in the not too distant future with barely any conventional monetary policy tools, larger debts, and deeper social instability. We will end up in a worse situation than we face now.
Ten years into the current era of postmodern central banking and it can be hard to recall just how much has changed in central banking. Believe it or not, central banks were not created to perpetually delay recessions. Central banks were created to constrain credit growth in the commercial banking system, deprive governments of the ability to monetize their debt, and be a lender of last resort during financial crises. All three of those objectives were summarized as ‘price stability.’
Since the Financial Crisis, central banks have become increasingly uninterested in those traditional objectives and much more interested in things like the wealth effect and exactly 2%-at-all-times inflation targets. Central banks now indulge in the delusion that eliminating recessions is both possible and desirable.
Recessions Are Healthy
As we frequently note here at The Sounding Line, recessions are a healthy, necessary part of the economic cycle. They keep investors, businesses, and households disciplined. They remove overcapacity and make room for innovation and evolution. The US has endured 42 recessions and five depressions since the 1780s. The US economy recovered from every single one, returning to growth within an average of roughly one and a half years. That includes the 39 recessions and depressions that proceeded the establishment of the Federal Reserve in 1913, and the 20 that occurred when the US had no central bank at all. The eras of the most robust growth in American history have been punctuated by frequent recessions, not long stretches without them. If you are 65 or older, you have lived through no less than ten formal recessions. Most were entirely forgettable affairs.
Yet today’s policy makers have become so deeply moribund over the prospect of a single recession that it has them mortgaging us, our children, and our grandchildren to decades of rising debt and slowing growth. All for what? Two more years of ‘expansion?’ Three?
One of the reasons that the American economy has bounced back from recessions so quickly is because our central bank has tended not to gamble with the foundations of our free market system on hare-brained schemes to stretch expansions out for another couple years. At least not until now.
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