The Federal reserve is cheapening the recovery with low interest rates

Earning money too easily has its own risks. First fed the real-state bubble, now, despite what we could think, could be cheapening the economic recovery.

When reducing the interest rates to almost 0, the Federal Reserve helped to prevent an economic collapse. However, in front of a weak recovery, many thing than the Federal Reserve is creating deflation.

The question of the million is why banks aren’t spreading credit, specially to small companies who are the motors of economy. One of the answers is that there isn’t demand of credit, but the lack of supply has his role too.

Ronald McKinnon, a teacher of economics in the University of Stanford, says that interest rates near to 0 brake the inter-bank market, what affects the growth of credit. According McKinnon, big banks doesn’t lend to small ones because the profit they might take is ridiculously small.

According data from the Federal Reserve, the amount of pending inter bank credits at the end of May was around $160 Bn, what supposes a fall by 60% in a year.

At the same time, banks are reducing credit and accumulating funds. According showed data from the Federal Reserve, its amount of Treasury Bonds and governmental debt increased by 19% respect the previous year. Industrial and commercial loans fell by 18%.

Small and medium companies have been the most affected. In the first quarter, the pending debt of small and medium companies fell by $70Bn, according data from the Federal Reserve, while big companies have seen his debt increased by $100Bn.

The negative to give credit is understandable. Banks can obtain cheap money to invest in high profitable governmental debt, a phenomenon called carry-trade.

This contrasts with consequences that interest rates nearly 0 have on investors, that had to move to risky assets in order to obtain something for his money.

Making money more expensive, would damage the economy, because some companies and individuals paid more for the float rate of his debt. But it could compensate banks to increase loans in inter-bank market. Profits from carry-trade investments would be reduced and banks may try take higher performances with traditional loans.

In this case, “increasing interest rates could have an inflationist effect” Comented Jopseph Mason, Finance professor inn the University of Louisiana.

The Federal reserve is who has to decide whether take odd measures or continue with a so aggressive monetary policy.

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