Since the 2006–07 financial crisis the Federal Reserve has taken several steps to stimulate the economy and unfreeze credit markets, which had ground to a halt after the bursting of the housing bubble. The Federal Reserve launched its current monetary strategy in 2007, with two major initiatives. The first was a cut in the federal funds rate from 5.25 percent to effectively zero by the end of 2008. The federal funds rate remained near-zero for seven years; the Fed only began to increase rates again in December 2015.
The theory behind the zero interest rate policy (ZIRP) is that low interest rates stimulate investment while allowing consumers and businesses to finance large purchases more easily, resulting in more products and services being produced and lower unemployment. Low interest rates are also said to lessen the federal debt burden and encourage banks to lend and invest their money because the rate of return makes holding it less profitable.
A ZIRP has significant consequences, however. A long-term ZIRP erodes the value of savings and investments, creating what can best be described as a hidden tax, with investors paying for the cheap money to banks with the diminished value of their savings accounts. The influx of new dollars into the money supply has devalued the existing currency already in the economy, reducing the value of all savings and retirement accounts.
The result of this devaluation of savings is to push investors into higher-risk areas such as the stock market. This may spur the economy in the short run, but it is likely to lead to stock bubbles that will crash people’s retirement plans.
Another damaging element of the ZIRP is the interest payments the Fed is sending banks for money held in reserve. By stopping those payments, the Fed could increase lending by removing this artificial incentive to hold cash in reserve, critics argue.
The Federal Reserve’s ZIRP has done little to stimulate the economy and has done much to hurt investment and savings. The Fed should implement new policies that promote a strong dollar and interest rates based less on manipulation and more on market forces.
The second major monetary policy effort by the Fed was quantitative easing. Under quantitative easing the Fed purchases government securities or other securities from the market in with the goal of lowering interest rates and increasing the money supply. Quantitative easing increases the money supply by channeling dollars into financial institutions, providing them with increased capital in order to promote increased lending and liquidity.
Critics of quantitative easing argue it represents a form of crony capitalism because it allows the government to pick winners and loser between financial institutions, all at the expense of taxpayers. These are legitimate concerns, quantitative easing does direct manipulate investment in the financial market and has acted to prop up the housing market. This giveaway to the financial industry has done little to help the average taxpayer, the new funds have served to increase the cost of commodities, which has increased the cost of many consumer goods.