Here’s the problem:
Ratcheting its key rate from the current 1 percent all the way down to zero can’t be ruled out. But there are risks in taking such an unprecedented step: namely, that it wouldn’t work in turning around the economy and breaking through a stubborn credit clog.
Eventually, a zero percent rate — virtually “free” loans for banks — could trigger a speculative investment frenzy that could feed a bubble that pops, wreaking havoc on the economy. Former Fed Chairman Alan Greenspan — now partly blamed for the current problems — has called today’s crisis a “once-in-a-century credit tsunami.”
Back when Paul Krugman was still an economist with original and daring thoughts to share, he came up with a novel solution to Japan’s deflationary recession of the 1990s. Namely: Run the presses! Let people know that inflation was coming, so they’d better spend yen today or find them worth less tomorrow.
Seriously, it was a radically simple idea; if deflation is the problem, inflate your way out of it.
But now? I dunno. We’re in a period of asset deflation, but the government has been running the printing presses at full speed (with concurrent reductions in the prime) for ages now. And we’ve been through a period of commodity inflation (think oil and metals) for a while. So money supply is going up while commodity prices fluctuate pretty wildly and demand is depressed.
Oh, and currencies are all over the place.
What’s going to happen? Hell, I can’t even figure out what’s already happened.