15 Aug 2009

The Government Has Paralyzed the Credit Markets

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The government (including the Federal Reserve) has paralyzed the credit markets. It has attacked the markets in many ways, but one particularly insidious move was the inject a massive amount of new reserves, and then pay interest to keep them bottled up.

This is one of the most perverse outcomes of the Fed’s combination of decisions. Because nominal interest rates have been pushed so low, it is relatively cheap for the Fed to turn itself into the ideal place for banks to park reserves. In a booming economy with nominal interest rates at 7%, it would be very expensive for the Fed to bribe backs into restricting their loan portfolio. But not now, with the fed funds rate hovering at 0%.

In yet another case where the government creates the very problem it was (supposedly) trying to solve, check out this graph. Remember, the unprecedented actions were justified as a way to patch up the “credit crunch” and to unclog or unfreeze the credit lines on which businesses rely.

Isn’t it ironic, then, that–as the graph shows–bank lending didn’t go down until after Bernanke shot the moon? There was no “credit crunch” before that intervention.

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