Kudlow, Yellen Are Right, Fed Must Slash Rates Now

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.

At the time, the federal funds rate was 5.25%. By the end of 2008, the rate was near zero. At the same time, the Fed began to massively increase the money supply.

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.