The extremely low interest rates we have these days in the U.S., Europe and Japan are part of the continuing effort by central banks to avoid deflation and promote economic growth. During the financial crisis that began almost a decade ago now, the Federal Reserve took what would previously have been considered extreme measures to avoid deflation and depression. Massive deficit spending by the Federal government was another measure designed to stimulate the economy.
Whether it was because of those measures or just by luck, we did avoid what some people had been saying would be the worst economic disaster in history.
Those measures were the opposite of the response to the 1929 stock market crash and the deflation that followed it. During that time the Federal Reserve kept a tight clamp on the money supply, and until Franklin Roosevelt and the New Deal came along there was no increase in spending in the Federal budget.
A great many economists have studied the effects of the Federal Reserve’s actions during the 1930’s, and the consensus of opinion is that the Fed did the opposite of what it should have done. Thus, this time they did the reverse. We have to admit that the results have been much better. Rather than the end of the world as we know it, we have had relatively minor and brief discomfort. We have to say, however, that the full history of this event has yet to play out.
It sometimes seems that there is an excessive phobia on the part of the Fed about deflation and almost a desperation to bring about at least a low level of inflation. For many of us who had become accustomed to fearing inflation, the desire to have it seems counterintuitive. Why can’t we have a little deflation? Give the consumer a break.
Nevertheless, the economy does continue to be anemic and apparently fragile. If the continuing stimulus provided by the Fed were to go away, the result might not be good.
However, there are other things going on besides the stimulus by the Fed. There are continuing deficits in the Federal budget. There is a continuing torrent of red tape coming out of Washington, the general effect of which is to have a dampening effect on business activity. The tax code is counterproductive. There are endless and continuing trade deficits (although economists differ on whether this is good or bad). Our European trading partners have been weakened by financial and economic problems of their own. The total effect of all these things is probably too much for any economist to calculate. Certainly you can find any opinion you want in this so-called science.
It may be that future economic historians will pronounce that the Federal Reserve’s fear of deflation in these times has crossed over into the territory of being an overreaction caused by fear of repeating the 1930’s. For us consumers, investors and business people, we can only proceed, as usual, without the benefit of hindsight, and try to make the best judgements we can in our personal, investment and business decisions.