Feckless Monetary Policy, Fiscal Inaction and Regulation Stymie Economic Recovery

14 Pages Posted: 21 Jul 2014

See all articles by William J. Dodwell

William J. Dodwell

Consultant to Financial Institutions

Date Written: July 16, 2014

Abstract

Five years after the Great Recession the economy continues to struggle because of misguided monetary and fiscal policies that have diverted capital from Main Street to Wall Street and Washington. Chronic near-zero short-term interest rates, well below the level of inflation, have infused so much liquidity as to create a flight to financial assets at the expense of normal growth in a drought-stricken economy. Indeed, misplaced capital stifles Main Street through a dearth of bank lending for consumption and capital investment that combines with onerous taxation and regulation that further deter economic recovery.

Some speculate the Federal Reserve’s long-standing easy credit policy is intended to recapitalize the banks after the financial crisis and provide cheap financing for federal spending rather than stimulate growth. In any case, uber liquidity directs investor capital to risky stocks and bonds in a desperate quest for higher returns to overcome low interest rates, which also prevent banks from lending profitably. Meanwhile, the real economy starves for investment that produces jobs and growth. What’s more, through continued profligate spending the government amasses record debt that consumes an ever greater share of GDP. Specifically, that spending siphons productive capital from the private sector in the form of government bond purchases and taxes paid that would otherwise support consumption, business investment and employment.

New financial regulation, albeit salutary in some respects, overly restricts bank liquidity and credit availability needed to service a growing economy, especially small businesses that produce most jobs. What’s more, government prevents promising oil and gas development, and imposes punitive regulation that undermines the law it enforces to the detriment of economic growth. Furthermore, government seems to create disincentives to work through overgenerous benefits that smother ambition and suppress production.

The Fed should begin to raise short-term interest rates to inflation-adjusted levels to enable banks to overcome new regulatory capital restrictions and profitably lend to small businesses and startup companies that finally would fuel normal economic recovery. In turn, that activity would prompt corporations to invest their $2 trillion of idle cash in new production for further stimulation. In addition, higher rates will redirect capital from Wall Street to Main Street and defuse potential asset bubbles in the financial system while rewarding long suffering savers who will have more to contribute to consumption. Tighter credit, commensurate with inflation and employment levels, would restore an equilibrium between lenders and borrowers, notwithstanding some temporary discomfort in the transition.

Additionally, substantial spending cuts, tax reduction, and regulatory relief would return capital to the private economy and stimulate areas of sluggish demand to foster the economic growth to be expected five years after the Great Recession. If only politics would cooperate.

Keywords: monetary policy, fiscal policy, regulation, inflation-adjusted interest rates, bank liquidity, government spending, economic recovery, financial asset bubbles, private economy

Suggested Citation

Dodwell, William J., Feckless Monetary Policy, Fiscal Inaction and Regulation Stymie Economic Recovery (July 16, 2014). Available at SSRN: https://ssrn.com/abstract=2468623 or http://dx.doi.org/10.2139/ssrn.2468623

William J. Dodwell (Contact Author)

Consultant to Financial Institutions ( email )

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