In 2007, as the economy was slowing and about to enter what turned out to be a very severe recession, the Federal Reserve began to cut interest rates.
While most economists credit the Fed’s monetary policy for putting an end to the recession, the policy never led to an expansion. In theory, as a result of the Fed’s actions, either economic growth should have increased significantly or there should have been a large inflation problem. Neither happened.
The reason for this is that monetary policy will have a simulative impact on the economy only if there is a multiplying effect on the overall money supply. The multiplying effect occurs when banks lend money to consumers and the business community. Because Congress passed the Dodd/Frank bill in 2010, lending was severely curtailed.
No lending meant no multiplying effect. No multiplying effect severely minimizes the impact of monetary policy on the entire economy. As a result, the economy continued to show meager 2% growth for the next decade, while inflation remained very tame.
Last year, Congress reversed much of the negative impact of the Dodd/Frank bill. That action freed banks to make loans. Couple that with the tax cut Congress passed in 2017 and the economy should have seen rapid economic growth. Growth increased only to a rate of just under 3%.
The growth rate should have been much higher. The Fed’s more than two-year restrictive monetary policy, which has increased the interest expense for business by as much as 50% is placing a burden on economic growth.
Because interest rates were reduced to near zero in 2008, by 2016 the Fed felt it was time to raise rates to more normal historical levels, even though the economy never entered an expansion and growth remained in the 2% range with was no sign of inflation.
They said their reason was that the low rates would mean the Fed couldn’t reduce rates any further should the economy slow down in the near future.