The Federal Reserve’s zero rate policy (ZIRP) is designed to fool long term investors, particularly businesses into expanding a business, etc. yet it mainly is used by short term speculators who are afraid to commit to long term ownership and instead seek short term speculation. If Fed policy was that rates would be guaranteed to be low for decades then businesses would react differently. Even though low short term rates can act to pull down long term rates and thus give some people a fixed rate loan, the problem is that not every one or every project can qualify for a long term fixed rate loan. Further a project such as buying rental real estate is contingent upon selling it a decade in the future to a new buyer who will also need a low rate fixed rate loan. If today’s buyer worries that rates will rise then he may fear that future buyers who buy from him in the next cycle will not be able to afford it and that today’s low rates act as teaser to make asset prices artificially and temporarily high and are thus a setup to failure.
Thus ZIRP doesn’t really help the physical economy. Instead it encourages very volatile unreliable speculation as investors load up on marginable liquid assets which they plan on instantly selling when trouble hits. Thus the market becomes more prone to Flash Crashes, popped bubbles than it would have if no ZIRP had existed. Thus due to uncertainty a lesser amount of good investments in plant and equipment are made and instead undesirable non-productive speculative investments are done, so as a result society is no better off and may actually be worse off due to damage from burst bubbles such as people stuck in negative equity houses who can’t move to a new job. Also low rates impoverish moderate income retirees who depend on bonds because they dislike stocks; low rates hurt these people’s consumer confidence yet the benefit of low rates encouraging working age consumers to take on more debt may be asymmetric where workers may fear that even if rates are low that taking on more principal payments is a risk, or in the case of businesses debt the risk is great that amortizing the payment of the principal will be bigger than the benefits from buying new equipment. One symptom of current cycle is lack of capital deepening (lack of buying of new equipment). If business fears that low rates are a temporary teaser then they won’t take the bait.
The result of making the economy more bubbly and prone to crashes is that the physical economy or the GDP’s Sharpe ratio has been lowered due to increased risk and thus investing in GDP is less desirable on a risk adjusted basis. This can be seen where employers offload risk onto workers forcing them to work as independent contractors or forcing them to accept contingent pay such as constantly changing number of work hours, etc. Then these workers react by reducing their consumer confidence and buying smaller houses, etc. A lower Sharpe ratio for the owner of physical plant equipment is the result of constant boom and bust cycles where the owner seeing that he may be hit with a steep crash will try to get by without capital deepening during the expansion cycle because the downside risk of being stranded after buying expensive capital goods during a brief artificial boom is too great of a risk. Ultimately only smart wise people get to make major economic decisions and they are choosing to not believe manipulative actions by the Fed such as artificially low interest rates.
Ultimately the worst thing about ZIRP is that it may be a setup to failure where it starts to stimulate the economy just enough to fool people into taking on too much risk and then it loses credibility and then people are stuck owning bubby assets or unneeded expansion of a business.
Investors need independent advice about the risks of Federal Reserve created stock market bubbles.
I wrote an article “Fed’s zero rate policies are deflationary”.