Absurdly Happy about the Fed

The powerful U.S. Federal Reserve set off some fireworks Wednesday evening … by doing absolutely nothing. Contrary to earlier statements, the Fed decided not to reduce their billion-dollar quantitative easing policy. They will continue to spend $85 billion per month on asset purchases, which amounts to $1.02 trillion a year. For stock exchange junkies, this is a reason to celebrate.

However, the news that the U.S. Federal Reserve refuses to begin even slowly reducing funding is worrisome, because the Fed’s economists had to rescind the growth forecasts for the largest national economy in the world. The 17 Fed policymakers are suddenly afraid of their own shadows. U.S. interest rates have risen more than a percentage point since May, when they hinted that they might soon reduce bond purchases. This intensification of the financial situation could have precisely contributed to the slowing growth that a tighter financial policy now eases. The economy, as indebted as ever, groans more than expected under rising interest rates.

The short-term changes in expectations for growth cannot obscure the Fed’s underlying problem. It wants to achieve two things through low interest rates. One is to stimulate investment. With its billion-dollar support purchasing, the Fed relies on a very shaky theory: “The Wealth Channel.” Rising stock and estate prices are supposed to encourage consumption, but this effect is highly debated among economists.

Because the larger stock fortunes are unequally distributed and in many cases represent retirement plans, the average American does not run to the nearest Apple store or Wal-Mart just because the S&P 500 Index has reached a new record. Real and finance economies are not as connected as the Fed seems to think. Corporations are using the record-low interest rates to take on new debt, but rather than investing in the real economy, they are investing more heavily in acquisitions.

The finance markets, therefore, remain in an absurd condition. Bad news about the state of the real economy can mean a win for the stock market because only bad news feeds hope of more money from Washington.

The problem for the Fed is that they can only support the real economy indirectly. Low interest rates and cheap money do not really reach it. That does not mean, however, that the Fed needs to do more. Rather, it must coordinate better with the other players in the U.S. economy, especially the politicians in Washington, who, due to a blockade in Congress, are steering toward yet another budget crisis.