Consumers and businesses would borrow this cheaper money from the banks and presumably spend it or otherwise put it to use, thereby stimulating the economy and vanquishing the evil of deflation. In theory, as the economy recovers, interest rates are allowed to rise back above the zero bound.
Of course that was the theory when we went to zero rates some six years ago. At some point the economy would recover and the Fed would normalize rates. Except the economy never got to a place where the Fed felt comfortable raising rates even minimally – until last December. And now the high priests of the FOMC are signaling that it might be longer than they originally thought before they swing their incense orbs and raise rates again.
There are some (including me) who would argue that, rather than focusing on consumption, monetary and fiscal policy should focus on increasing production and income. By lowering (repressing) the amount of income savers get on their money, you push savers into riskier assets. That is generally not what you tell people to do with their retirement portfolios, (nor can we overlook the fact that the country is getting older). Thus if interest rates are artificially low because of Fed policy, that reduces the amount of money retirees have to spend. The Federal Reserve and central banks in general seems to think it’s better to have consumers borrow than save.
It’s a Keynesian conundrum. If nobody spends and everybody saves, the economy slows down. While it may be a good thing for you individually to save and prepare for your retirement, if everybody does so at the same time the economy plunges into recession.
Now let’s get back to the intersection of economics and religion. There are multiple competing economic theories on the government’s role in monetary policy making. The operative word is theories. Each is an attempt to describe how to manage a vastly complex modern economy. Some see too much debt as the cause of our current malaise. Others think that lowering taxes would allow consumers and businesses to keep more of their income and hopefully spend it.
In the not too distant human past, shamans and soothsayers conjured theories about how the world worked and how to predict the future. Some examined the entrails of sheep, while others read meaning into the positions of the stars (or whatever their prevailing theory dictated) and told leaders what policies they should pursue. An astute priest would pretty quickly figure out that the best route to priestly job security was to foretell success for the politician’s/king’s/tribal chief’s pet policy course.
In today’s world, economists serve exactly the same function. They skry their data sets – a latter-day version of throwing the bones – and then, based on the theory by which they believe the data should be interpreted, they confirm the orthodox policy choices of their political masters – and so their careers prosper.
This is not to disparage economists – not at all. They really do try to come up with the best possible policies – but the range of policy alternatives is constrained by the economists’ (and the general society’s) belief system. If you believe in a Keynesian world, then you will prescribe lower rates and more fiscal stimulus during times of recession.
If, however, you believe in a competing model, such as the Austrian theory postulated by Ludwig von Mises, then you believe that smaller government, far less fractional reserve banking (if any at all), and a gold standard are appropriate. A recession should be allowed to “clear,” permitting defaulting borrowers to reduce their debts and putting the assets that collateralized their loans back on the market at reduced prices, thereby encouraging businesses to employ those now-cheaper assets in income-producing activities. (This is a very simplified explanation.)
There are other competing theories, each with its own model of how the world works. There is convincing logic and a believable rationale behind each theory. If we had adopted an Austrian model in 2008–09, we would have had a much deeper recession and unemployment would have risen higher, but the recovery would theoretically have come more quickly as prices cleared and debt was resolved. However, that period of time before the recovery began would have been devastating to the millions of families who would have faced even more crippling unemployment than we saw. That is an experiment we did not conduct, so we will never truly know whether that path might have been less painful in the long run.