The New York Times reported last Monday that, in the middle of a recession, corporations are taking full advantage of the Federal Reserve?s low interest rates, even though they see no investment opportunities and have no intent to expand. The Times mischaracterizes this as evidence of ?the limits of government policy.? It is, to be sure, evidence that the current policies aren?t going to get us out of the recession and possibly aren?t even intended to do so. But it is not evidence that straightforward Keynesian fiscal policy wouldn?t work.
If the Democrats had the spine to resist Republican demands to sacrifice the country on the altar of Reverse Robin Hood Redistribution?taking from the middle class to give to the rich?we could be using the recession to take advantage of economics?s only free lunch. The federal government could simultaneously put people back to work, improve our competitiveness and prospects for future growth, and make the essential infrastructure investments to counteract global warming, reversing thirty years of neglect.
The Fed lowered interest rates to induce corporations to invest, thereby putting people back to work. Instead, corporations are borrowing without spending. This is exactly what we?d expect under a standard Keynesian account. Recession means that fewer people are working. Meanwhile, those who still have jobs worry about their futures and, rationally, cut back on their spending as well. Meanwhile, all those cutbacks mean fewer people working, and fewer people working means less income, which means less demand. People who aren?t working can?t spend and people who fear losing their jobs won?t. Companies that can?t sell their products cut back on costs?which means jobs?to avoid insolvency, but every cut job is still more demand eliminated in the economy. We are stuck in a downward spiral driven by lack of demand. Companies can?t sell the products and services they are making now. Why would they invest to create more?
The standard Keynesian policy solution is for the federal government to increase its spending. It could cover state deficits and save teacher jobs. Or it could hire people to build new energy infrastructure, or insulate our buildings, or rebuild our railroads, bridges, and roads to reduce costs later, or fund the research that drives innovation and productivity. This would increase employment (at no social cost, since the resources being used were being wasted). Putting people to work both reduces fear and, more importantly, actually gives them the money they need to recreate the missing demand.
But this requires congressional approval, which with the new supermajority rule in the Senate is impossible so long as one party either blindly believes in Herbert Hoover economics or is prepared to sacrifice the country for electoral gain.
With Keynesian spending?fiscal policy?rendered impossible by a cowardly majority and an intransigent minority in the Senate, the second best policy response is for the Fed to reduce interest rates?monetary policy. No congressional action is required. The Fed directly controls the interest rate at which it lends to banks. If that doesn?t reduce interest rates to other borrowers, because banks take its cheap money and don?t lend it out cheaply, the Fed can move on to quantitative easing. Quantitative easing means that the Fed buys U.S. government bonds using money it creates from thin air (the bonds remain valid government obligations, but when U.S. Treasury pays interest, the Fed simply rebates it back to the Treasury). The Fed?s purchases decrease the supply of bonds available to other investors, and that reduced supply leads to increased price, especially when fear and uncertainty mean that demand for safe government securities is high anyway. High bond prices are the same as low interest rates.
For any corporation or investor using standard finance tools to calculate expected returns on planned investment, a lower risk free rate?the T-bill rate?makes every future payment worth more money today. The result is that when the Fed reduces interest rates, every MBA in the country starts seeing more attractive investment opportunities. For less formal investors, lower interest rates make it cheaper to borrow and reduce the benefits of saving?thus, again, making investment more attractive. Increased investment should mean more employment, and therefore more demand, in turn inviting more investment still.
The only problem with the low interest policy is that it is completely indirect. The Fed can lower interest rates. But it can?t make investors borrow and invest or consumers borrow and spend. Right now, individuals don?t want to borrow (lower interest rates make debt easier to handle, but too many of us already have too much debt even at low rates) and companies don?t want to invest (what?s the point of increasing capacity when you can?t sell what you are making now?).
Instead, if interest rates are really low because the Fed (but not Congress) is trying to fight the recession, corporations can respond by borrowing now, to protect the firm in case it can?t borrow later should it need cash. That?s the original liquidity story: the recession makes companies want to hold more cash, which reduces demand, which makes the recession worse. Giving them cash slows the downturn but isn?t enough to reverse it.
The Times reported that this exact scenario is now underway, but it failed to emphasize the other half of what is going on, which is quite unexpected given the Keynesian liquidity story: at the same time that these companies are borrowing to increase liquidity, they are paying out dividends. They are taking money in and paying it right out to their shareholders. Why is that? Shouldn?t they be hoarding?
One possibility is straight class warfare: the Fed is lending our money for free to corporations which are handing it over to institutional shareholders and the upper class. Intentionally or otherwise, this is just another transfer from the middle class to the tiny minority of Americans (and foreigners) who own significant amounts of stock, much as the increases in Social Security taxes and cuts in essential government services were used to fund income tax cuts for the rich. This explanation is sociological?i.e., about power?rather than economic. In the battle between liquidity and cupidity, cupidity wins.
The more innocent possibility (although with similar consequences) is corporate finance. From the perspective of standard business school finance, a corporate treasurer?s job is to meet the company?s needs for money as cheaply as possible. The standard theories make it quite clear that the question of how to raise money can be completely separated from the question of how much money is needed.
So well-trained treasurers will take advantage of the Fed?s largesse, even if someone else, somewhere else in corporate headquarters, has just decided that the company has no need for cash, is not going to invest in the near future, and can get the labor and other resources it wants without paying more. If the company doesn?t need the money, it will just pay it out to whoever can grab it?the CEO, most likely, but if he or she has already taken as much as the limited remnants of decency allow, then the shareholders.
The upshot is deeply disturbing. The Senate?s failure to overcome the Republican/Blue Dog refusal to help ordinary Americans means that people are sitting unemployed unnecessarily. The government?s failure to spend when spending is costless means that we will all be poorer in the future?without the infrastructure, transportation, new energy sources, environmental protection, research and development, or other public investments that could have made the economy more productive for years to come or pushed off the global warming crisis for a few more years. And the Fed?s attempt to make up for congressional failure is exacerbating the inequality that is the primary cause of our problem in the first place. The sin of Sodom, according to the Talmud, was that the Sodomites did things that caused injury to others with no conceivable benefit to themselves. The sin of the filibustered Senate is worse still: to hurt ourselves simply in order to make our own society worse off.