by Giuseppe Timpone

Created on: December 02, 2008

FEDERAL RESERVE'S MISTAKES

What the United States are facing now is the consequence of a wrong Fed's monetary policy. In the '80 years, President Ronald Reagan started pursuing a so called "monetarist" strategy, in order to make the monetary mass diminuish, to fight inflation and make the American economy more efficient, what really happened those years. This strategy was abandoned in the '90 years, following the wrong convinction that an expansive monetary policy, consisting in low interest rates, would make the American economy grow at a faster pace, than in the other case.

This strategy gave short-run benefits to the US economy, with growth rates doubled than the European economy. But the burst of the newco bubble at the beginning of the millenium effectively showed the dangers linked to this sort of policies.

Low interest rates make the monetary mass grow, as consequence of a lower savings rate and of more investments. This stimulates consumptions, because the fellows are non interested in savings, as these are not appropriately rewarded. This excess of money in the hands of people provokes inflation, as prices of goods and services grow. Not only, this policy ecourages speculative attitude, as people try to use this excessive money at their disposition, by purchasing shares and private bonds. As a consequence, their value seems to indefinetively grow, and a sort of financial fever seems to happen. It becomes rational to buy shares, thinking their value still grows, not for a better perfomance of its company, but just because people will very probably go on buying it, as the liquidity of the financial and economic system is too high. The final result of this story: the economy is living over its possibilities. People is spending too much and is saving too little; shares and financial assets are significantly over-priced. This sistuation will last, until something or someone must put an end to it. People will realize, the shares they own are over-priced and that would be wiser to send them, earlier than other owners do it; the policy makers should rise interest rates, as the danger of a high inflation is drammatically becoming real. What happens, now? Shares are sold, their value fall down, panic comes and people go on selling everything they own; with the consequence that millions of people will have on their hands shares under-valued, now, and other millions of people, who have financed their path of consumption, by debts, as the interest rate drammatically rise, risk a personal default.

This happened in a less evident way, with the burst of the newco bubble, at the beginning of this millenium, as a consequence of a relaxed monetary policy, under President Bill Clinton. And in a more remarked way, this is happening, now!

What's the real cause of such as this disaster? Many people say: the financial deregulation; that means: We want more control on finance. This would the wrong remedy for a wrong sickness.

The real cause of this disaster lies in the wrong timing of monetary policy: too low interst rates before, too high after. And this is due to a not appropriate Fed's system, as the US central bank doesn't limit its dues at the inflation targeting, but also tries to substain the real economy, what seems to be strange in a free market country!

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