The Federal Reserve wields a lot of power behind the scenes. To combat the recession, the Fed has kept key interest rates low and made it easy for banks to borrow money. Yet some say this generous policy might now be hurting the economy. How so? Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds.
“Well … here is what the critics of the Fed see: Banks can effectively borrow now from the Federal Reserve at a 0 interest rate. They can then turn around and invest those monies with the federal government, that is buying federal debt, and earn a very low yet modest — and actually risk-free — interest rate. And so many critics of the Fed say this is exactly what banks are doing: They are taking that 0 interest rate money, turning around, lending it to the government — maybe earning a percent or 2 percent, but it is totally risk free. And the banks therefore have little incentive to go out and try to find private sector loans to make.
“And so what these critics say the Fed actually ought to do — and it is somewhat counter-intuitive — is increase the interest rate that they charge the banks for the banks to borrow money from them. This will then motivate the banks to go out and find higher-interest-rate loans that are going to be in the private sector, and it would get the money in the private sector, especially to small business.”