TC is PC for Monetary Policy

I learned a new word today – TC. TC is not really a word but it is already being bandied about in the news – Time Commitment.  I have to admit that in all my years of teaching macro and money I never once used that term. Apparently TC implies a promise by the Fed to keep interest rates low for two years. It is kind of like me promising to not eat giant ribeye steaks for two years… it sounds like a sane thing to do but it probably ain’t gonna happen.

That is not to say I am not relieved that the market headed upward yesterday. I appreciate that. But like many things in this world, I am not completely convinced that the relief investors felt yesterday is going to last. I know – you hate it when economists spread gloom and doom – but let’s face it – TC really means two things. First, it means that the Fed did almost nothing yesterday. Second, it means that the Fed raised – not lowered – the riskiness of our economic environment.  I started writing this BEFORE the market opened today but I just looked and it appears that the DJ is down almost 400 points!

Promising to keep interest rates low for two years seems to have reassured frantic investors for a moment but what have they really done with this promise? They did nothing insofar as policy goes to reduce interest rates further. They did nothing to change the amount of reserves in the banking system. They did nothing to generate a new loan or make banks more willing to make loans. They did make a promise – one that cannot and will not be kept. What we most care about for economic activity is longer-term rates and the Fed has no magical or direct influence on these rates. They are set in markets. When the economy slows down or when inflations expectations decrease – interest rates decrease. When the economy speeds up or if inflation signals higher future prices interest rates often rise.

In short TC might be PC (since it appears to have assuaged investors for a day) but it didn’t do one positive thing. But it does promise to come back with a royal boot to the national buttocks. Did you hear anyone saying last week that the reason all hell was coming unglued was because interest rates were too high. I don’t recall because I was being run over by debt ceilings and government debts and Chinese inflation and several other things. But nowhere in that economic haze was anyone crying about high interest rates.

So what gives? Some analysts are pointing out that the economy is very weak. They believe that the Fed’s actions will somehow strengthen the economy and therefore have a continuing positive effect on the stock market. But if trillions of additional reserves supplied by the Fed during the last two years didn’t work, then why would a silly commitment to keep interest rates low for the next two years have any impact on anything?

The most tragic thing about what they did yesterday is that they scared the hell out of us by underscoring two points. First, they admitted that the government has no more tools to use to stimulate the economy – even in the short-run. Second, policymakers at the Fed are so alarmed at the current weak economy that they have to drum up a silly policy that everyone knows has nothing to do with our current ills.

We all know why the market fell and we all know that it has nothing to do with interest rates that are too high. If our problems today have anything to do with monetary policy, they probably stem from too much outstanding money and the risk of higher inflation. Some economists have clearly pointed out that inflation is one of the few ways to “solve” our debt overhang. Rating agencies have also been very clear that such a policy will only lead to future downgrades. So if anything, a policy that ends up with even more monetary policy stimulation increases the risk of more trouble down the road.

Finally, the problems in the market are probably more dominated by non-monetary factors. By admitting that all we have left are monetary tools – we once again take our eye off the ball. If this monetary action takes the heat off Washington and stalls or prevents them from IMMEDIATELY solving our deficit/debt/regulation issues – then the public will once again be duped by our snake oil sales staff in DC. The market seems to be recognizing this fact this morning. But today’s market performance is not the final judge – what matters is the future course of the economy.

I read and heard experts saying that the Fed just HAD to act! They had to show that they are very concerned about the economy. I am afraid that the combination of the government’s inability to act and the Fed’s over-willingness to save the day underscores just what is wrong with our country. This has got to be the height of national irresponsibility.