The Fed’s Loose Money, Financial Markets and Business Investment

By at 29 October, 2015, 8:14 pm

Federal Reserve

by Raymond J. Keating-

The Federal Open Market Committee issued its latest statement on monetary policy on October 28. Of course, financial markets have been ramping up the intensity of the Fed watching game, as speculation persists as to when the Fed might hike short-term interest rates.

But while many in the financial markets are worried, or focused on a tiny move in the fed funds rate, entrepreneurs, businesses and investors in the “real” economy have been and continue to be worried about the ultimate effect of the Fed’s unprecedented loose money that’s been running for now more than seven years now.

The relevant part of the FOMC statement included the following: “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.” And later: “When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

Again, Fed watchers jumped on this as being a signal that the fed funds rate might be bumped up in December. But, as made clear in the FOMC statement, loose money will be with us for some time. A quarter-point increase in the fed funds rate, whenever it is implemented, does not signal any real tightening in monetary policy.

An analysis in The Wall Street Journal by Michael Spence, a 2001 Nobel laureate in economics, of New York University, and Kevin Warsh, a former Fed governor, of Stanford, highlighted the key point regarding the negative consequences of Fed policy – a point that SBE Council has been emphasizing for much of the past seven years. (See recent analyses, for example, here, here, here, and here.) That is, the Fed’s loose money has created enormous uncertainty, and thereby helped to restrain business investment. Poor business investment, in turn, leads to slower economic, productivity and income growth.

How the Fed has Created Uncertainty

Spence and Warsh put it this way: “How has monetary policy created such a divergence between real and financial assets? First, corporate decision-makers can’t be certain about the consequences of QE’s unwinding on the real economy. The resulting risk-aversion translates into a corporate preference for shorter-term commitments—that is, for financial assets.”

And later, they explain: “For real assets, the benefits of QE are far less obvious—and the results far less impressive. Weak economic data and mixed messages from the Fed in recent months only heighten our concerns about the trajectory of the economy and the sustainability of U.S. financial-asset prices. Inadequate capital investment means that labor is also underutilized. The impact of low capital investment is apparent in the weak productivity statistics. Productivity—key to raising wages and living standards—rose less than half of 1% annually in 2011-14, the weakest four-year run in productivity outside of a recession since World War II.”

By the way, the Fed has not only created uncertainty for publicly traded corporations, but for small businesses and the investors who supply vital financial capital to these entrepreneurial enterprises. Loose money might gin up stock prices in the short run, but it only does damage to entrepreneurship, real business investment, productivity, income growth, and job creation.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.



News and Media Releases