These myths have been made popular in the mainstream mainly by Keynesian economists trying to influence public policy.
Myth No. 1: The Key Element of Economy is Consumption
Consumption is, in reality, important in a free economy: especially the freedom of consumers to buy goods in unrestricted markets. However, it is investment (savings) – the total opposite of consumption – that holds the key to long term economic growth.
Consumption-promoting public policies, like low interest rates, do so at the expense of savings. Fewer saving means less investment; and an economy that consumes all its resources without saving or investing, will eventually end up bankrupt.
Myth No. 2: Excessive Consumption is a Trait of the Free-Market Capitalist System
Excessive consumption is actually a result of central bank’s artificially low interest rates, which promote lower savings and higher consumption than would naturally occur. At this time, the real interest rates of savings accounts are negative; therefore it doesn’t make any economic sense to save. Since it’s these same policies that cause price increases, it makes perfect sense to consume as much as is possible and as soon as is possible, before prices rise. Therefore, we observe that excess consumption is actually the result of government’s policies rather than the capitalist free-market system.
Myth No. 3: Economy can be Helped by the Federal Reserve Interest-Rate Policy
It is almost impossible to come to terms with the fact that most Americans – inclusive of those who struggled so hard against central planning in the 20th century – strongly believe that the financial markets and the economy profit from the central manipulation and influence exercised by the Federal Reserve.
In order to sustain a target of low interest rates, the Fed has to add liquidity to the money supply by creating money without obtaining additional money. This is the legendry creation of money out of thin air, which has come under so much criticism. Many believe that this artificial injection of liquidity stimulates the economy and promotes growth. In truth, even though it appears to have created a bonanza, these monetary injections have to be paid back, eventually. This payback is made possible by higher prices, the so-called inflation that we talked about in Part 1 of this article.
Low interest rates also create a huge difference between the market’s natural rates and those that the Fed sets. Supply and demand of money – mainly supply of savings and demand for credit – is what should set interest rates in a normal, unrestricted market.
When interest rates are lowered artificially by the Fed, they are set below the market rate, which is established at the junction of the total supply and collective demand of money. Setting a rate below the market rate, results in higher demand for credit, putting the consumers into debt beyond normal levels. On the other hand, low savings account rates result in people withdrawing their money, lowering the market supply of funds. These differences are at the heart of the eventual credit crisis, which is usually preceded by the boom period that had been a result of artificially low interest rates.
In today’s world of economic recession and risky financial crisis, most consumers would demand a premium to deposit their money in a bank. Also, the current liquidity crunch should mean a lower market supply of money. Both these factors should be pushing the interest rates higher. If the markets were not interfered with by the Fed, interest rates would be higher and not lower.
Nice article…