OVERSHADOWED by the near panic over the specter of apossible recession, the principle of limited government intervention in the economy has gone out the window. The recent actions of the Federal Reserve such as interest rate cuts and the increase of nearly $200 billion in the American money supply have done little to improve the economy and instead have led to the grim prospect of high inflation which has many negative effects on the economy.
While these actions led by Federal Reserve Chairman Ben Bernanke are meant to keep the country out of a recession, in reality they will probably lead to the disastrous combination of both a recession and high rates of inflation, known as stagflation. Ironically, the policies of a supposedly conservative administration have increased government intervention in the economy over the last seven years and have led to the current crisis.
Many of the recent actions of the Federal government are little more than panicked intervention in the deteriorating economic situation which will make the inflation problem worse. Realistically, the Federal government can do little to soften a recession and instead should go back to its traditional role of fighting inflation and staying out of the economy.
This pattern began after the September 11th attacks when there were widespread concerns over the economy. As a result, then-Federal Reserve Chairman Alan Greenspan lowered the Fed funds rate, which largely governs the interest rates, to historically low levels. This led to a sustained period of very low interest rates that caused people to borrow large amounts of money.
This led to fairly strong economic growth for a while, but problems arose when too many people borrowed too much money including those who should not have gotten loans under so-called sub prime mortgages. This would not have happened if the Federal Reserve had left the market to its own forces. Instead, Greenspan kept interest rates artificially low for an excessive period of time and this caused an imbalance which led to too much borrowing.
We are now experiencing the consequences of that irresponsible intervention in the economy that has led to widespread defaults on loans made during the period of low interest rates. These loan defaults have led to a significant economic slow-down and the prospect of a recession.
Recently, the Federal government has done several things to address the economic problem, but realistically does little more than increase inflation. As mentioned earlier, Bernanke has continued to lower interest rates and pumped billions of dollars into the economy. In addition, the Congress has passed and the president has signed a nearly $200 billion economic stimulus package that will give tax breaks to the population.
Many leading economic analysts such as David Rosenberg, chief North American economist at Merrill Lynch, agree that the recent actions will do little to improve the situation. As Rosenberg wrote this week, "this latest experiment, as with the others undertaken thus far, does not address underlying credit problems, does not materially improve the solvency of the institutions exposed to assets under stress."
The net effect of all these actions by the Federal government is to significantly increase the amount of money in the economy. While this might sound like a good idea because it gives people more money to buy things and grow the economy, this money is not backed by anything and can only lead to higher prices. The problem with inflation is that it gives people a pessimistic feeling about the economy and prices of goods increase dramatically while wages are much slower to keep pace.
The idea that the federal government can keep the nation out of a recession has been discredited over the course of the last century. During the 1990s, the Federal Reserve proved effective in controlling inflation and this led to increased growth not direct intervention. Hitting the panic button on the economy will do little to help solve the current problem and may make it worse. Instead the Federal government should recognize its past mistakes and move in a responsible manner to curb inflation and help improve the economy.
Sam Shirazi is a Cavalier Daily associate editor. He can be reached at sshirazi@cavalierdaily.com.
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