As interest rates hit record low, what next?

The U.S. Federal Reserve cut its target interest rate to a never-before seen low of between zero and  0.25 percent.  The move was widely seen as a signal that the central bank will act very aggressively to boost the economy as it moves into unchartered waters. It is also, perhaps, a sign that it’s even more worried about the state of things than it has let on. So, interest rates have been cut as low as they can go. What next?

The Fed stated that it still has other “available tools to promote the resumption of sustainable economic growth.” That will involve pumping money directly into struggling financial companies. For instance, it plans to buy hundreds of billions of dollars worth of mortgage-backed securities from the government-sponsored Fannie Mae and Freddie Mac.  It may  also lend money against securities backed by things  like student and car loans. Presumably, this will help ease credit markets and get money flowing again. How well that will work is anyone’s guess. 

As Princeton economist Alan Blinder tells the Wall Street Journal, “The Fed gets an ‘A’ or ‘A-minus’ for effort and not very good marks for results.” The story from the New York Times  also ends with a critical note from  Blinder: “Right now, the crisis is created by the huge demand by banks for hoarding cash. The Fed is providing cash, and the banks want to hoard it. When things start returning to normal, the banks will want to start lending it out. If that much money is left in the monetary base, it would be extremely inflationary.”