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October 10, 2011

Is the Federal Reserve Holding Down the Economy?

Is the Federal Reserve Prohibiting Growth?

Historically, the Federal Reserve creates money when the economy is in recession to boost growth. While this recession creating the same response from the Fed, it came at an unprecedented level. Nobody knows how much money the Federal Reserve has printed since the 2008 financial crisis, but estimates fall in between $2 and $7 trillion.

Increasing the money supply and lowering interest rates are supposed to spur the use of money. Increasing the use of money can occur via more borrowing from businesses or more investment into activities within the economy. The result is the end of the recession and increased growth. The downside to this method is that it creates inflation.

In this economy, however, we have low growth and raising prices. Currently, GDP for the year is under 1% (normal is around 3%) while inflation is at 3.8%, the highest it has been since the crisis started. This raises an interesting issue as to whether or not the Federal Reserve is prohibiting growth rather than promoting it in the current economic environment.

I believe that the Federal Reserve’s excessive creation of money over the past couple of years is contributing to our sluggish growth situation.

The Federal Reserve’s involvement in our economy is giving the private investors (large and small) anxiety over their constantly dominating presence in our economy. Private investors appear to see the Fed’s involvement as a pessimistic outlook for the economy to stand and grow on its own versus any kind of significant stimulus.

This is causing investors to bank their money versus putting it to work in the economy. Instead of investing in private industry (via lending, buying stocks, starting businesses), private investors are hoarding their cash in bank accounts. The chart at the top of the article illustrates the massive hoarding of cash during the crisis, the drop to average levels after the recession “ended,” and the near identical increase in deposits during the past year.

In an effort to stimulate the economy, this money needs to be brought out and circulated. There are other factors weighing down on the markets now, but the Federal Reserve’s recent money creation initiatives are not going to help bring the economy back up.

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