The Fed’s Negative Effect on Entreprenurial Decisions to Invest

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The Fed’s QE programs have reduced rates of interest, especially on mortgage bonds. This has lifted stock prices and home prices. Yet there has been no really marked change in business investment and home building starts that is anywhere near proportionate to the size of these bond-buying programs. Why not?

I propose that one important reason is that entrepreneurs remember the most recent bubbles and the malinvestments that occurred during them. They know that the FED once again wants them to produce and they see the inducing price signals in the security markets, but they are reluctant to follow them up and get burned by making malinvestments. They know the trick that the FED is playing because the recent episode is so fresh in memory. Consequently, the recovery is not rebounding as vigorously as the size of the Fed’s programs might suggest would occur.

Now, if the Fed had not gone beyond QE1 and let the market determine interest rates and security prices without its interference, then entrepreneurs would have had a clearer view of prices and capital costs. They would have had a clearer view of what products to produce and in what quantities. They would not be sitting on their hands. In this way, by seriously contaminating market prices and interest rates, the Fed has retarded the process of natural recovery.

2:46 pm on December 1, 2013