The Fed is Still Fueling Growth

The Fed is Still Fueling Growth

May 3, 2005

The Fed is Still Fueling Growth
The Fed raised the Fed funds rate target 1/4% today to 3%; that’s 8 increases in a row since last June.

While everyone picks through the press release to try to divine what they really meant, let’s not forget one thing. Monetary policy is not the Fed funds rate, it is the availability of credit. And monetary policy is still aggressively expansionary today.

There are two U.S. economies, not one. The economy we read about made up of big public companies like GE, AIG, GM, and Microsoft. And the one we don’t read about made up of small private companies with names we don’t recognize. It is the one we don’t read about that matters. It comprises more than half of GDP and 3/4 of jobs.

Monetary policy impacts the 2 economies in different ways. It hits the PUBLIC economy by changing short-term interest rates, just like the textbooks, and by moving mortgage rates, which are priced against T-bills in the capital markets. Big companies don’t borrow money from banks. They get their money in the capital markets which are usually more or less open for business. For them it is the price that matters.

But monetary policy impacts the PRIVATE economy differently. Small companies can’t tap stock and bond markets; they get their money from banks and modern-day loan sharks. And banks are not always open for business. Monetary policy impacts the PRIVATE economy by causing temporary blackouts in lending, like the one we had from November, 2000 until May, 2004. Or by creating a gusher of bank lending, like we have today.

Make no mistake about it, bank and non-bank lenders today are cramming loans to business borrowers, then selling them to hedge funds and mutual funds, who in turn sell them to yield-starved savers and investors who can’t live on 1% money market yields.

As long as that remains true, monetary policy will be expansive, regardless of the Fed funds rate. That expansion is leading to very strong profits for business, and for strong growth among small companies. this is good for the economy, for jobs, for profits, and for stock prices.


John Rutledge

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