Federal Reserve to Make Up For Lowering Interest Rates by Lowering Interest Rates

One of the principle reasons for the financial crisis is the Fed’s past efforts to inflate the money supply by lowering interest rates below what the market would normally charge. This pumped literally trillions of dollars into the economy, which necessarily causes such things as the housing bubble–all that fake money has to go somewhere. As economist George Reisman put it in August 2007:

The genesis of the present problem goes back to the bursting of the stock-market bubble in the early years of this decade. In an effort to avoid its deflationary consequences, the bursting of the stock market bubble was followed by successive Federal Reserve cuts in interest rates, all the way down to little more than 1 percent by the end of 2003.

These cuts in interest rates were accomplished by means of repeated injections of new and additional bank reserves. The essential interest rate in question was the so-called Federal Funds rate. This is the interest rate that the banks that are members of the Federal Reserve System charge or pay in the lending and borrowing of the monetary reserves that they are obliged to hold against their outstanding checking deposits.

The continuing inflow of new and additional reserves allowed the banking system to create new and additional checking deposits for the benefit of borrowers. The new and additional deposits were created to a multiple of ten or more times the new and additional reserves and made possible the granting of new and additional loans on a correspondingly large scale. The sharp decline in interest rates that took place encouraged the making of mortgage loans in particular. The reason for this was the steep decline in monthly mortgage payments that results from a substantial decline in interest rates. The new and additional checking deposits were money that was created out of thin air and which was lent against mortgages to borrowers of poorer and poorer credit.

And so, what does government do? Of course, it considers lowering interest rates again:

As the economic wreckage piles dangerously higher, the Federal Reserve is prepared to ratchet down interest rates – perhaps to their lowest point in more than four years – with the hope of relieving some of the pain felt by many Americans.

We’re doomed.

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