The Perniciousness of ZIRP
Suppose that I promised to give you free chocolate for the next three years: How much chocolate would you eat today?
A pound? Half a pound? A few ounces? Or would you not eat any chocolate at all, once I made the announcement? After all, you’re going to have free chocolate for the next three years—seems silly to gorge on chocolate today, when you can have as much as you’d like tomorrow, or next week, or whenever you want over the next three years.
So free chocolate for the next three years? Great! . . . uh, only not right now, thanks very much: I’m kinda full.
But then what if I said to you, “Chocolate is free now—but I’m definitely going to raise the price in the near term. In a month, chocolate might be free—or then again, it might cost $1,000 an ounce. So get some while you can, because tomorrow, you never know!”
Well, obviously, to such an uncertain outlook, you’d go out and buy some chocolate now—because tomorrow, it might well be unaffordable.
In fact, it seems quite obvious that if you don’t know when I’m going to raise the price of chocolate, you’ll probably wind up buying—and eating—more chocolate than if it was free. A paradox? Sure—but true.
In point of fact, if the chocolate is free, you might not eat any chocolate at all. Every time you make the decision as to what to eat, you might well find yourself repeating the same mantra: “Chocolate is free—I can have it any time I want. So I won’t have any now.”
This is the problem Ben Bernanke and the Federal Reserve currently have—and it’s their own stupid fault: They have promised to maintain interest rates at effectively 0% until at least the end of 2014—they have in fact announced this zero interest-rate policy (ZIRP) as the hallmark of their strategy to reignite the economy—
—but then they’re surprised when businesses aren’t borrowing more. They’re surprised when lending is in fact contracting. They’re surprised when the American economy doesn’t start borrowing—and thus growing—like crazy.
So the American economy obviously doesn’t benefit from ZIRP. In fact, it stagnates because of ZIRP.