As Congress and the President continue to struggle over who can create the most damaging fiscal policy, the Fed announced that it will work alone to try to provide some economic stimulus. Unfortunately, this policy is likely to continue to be ineffective. The graph below explains why.
Providing low-cost reserves to the banking system will have no effect if there are no additional profitable lending opportunities. There will be few profitable lending opportunities when we have so much excess capacity and such sluggish growth. The dramatic growth in excess reserves illustrates this problem very well.
It seems that U.S. policymakers have learned nothing from the lessons of the Great Depression, nor from the more recent experience of Japan and Europe. Monetary policy was remarkably effective since WW II in reducing the magnitude of cyclical fluctuations. The liquidity trap, though, has returned with a vengeance.
I suppose we should be grateful that those charged with monetary policy are not working to make the economy worse.
