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Does the Fed’s Lowering the Interest Rates Strengthen Economic Growth?

It is quite likely that the sharp decline in the yearly growth-rate of money supply during February 2021 to June 2023 laid the foundation for increasing savings and genuine economic growth. The benefits of the decline in the money supply growth-rate on the economy are likely to be undermined by the artificial lowering of the policy rate by the Fed.

The artificial lowering is going to generate the misallocation of savings. This will weaken economic growth. Fluctuations in interest rates should reflect the preferences of individuals and not the central bank bureaucrats.

Does the Fed’s Lowering the Interest Rates Strengthen Economic Growth? Image Credit: Getty
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On September 18, 2024 the Federal Reserve (“Fed”) lowered its policy interest rate target by 0.5 percent to 5 percent. Most commentators, including the Fed chairman Jerome Powell, hold that the lowering of the policy rate is going to strengthen the economy. This way of thinking is based on the view that the lowering of interest rates is going to strengthen the demand for goods and services. As a result, this would strengthen the production of goods and services (i.e., generate economic growth). Supposedly, an increase in the demand precedes an increase in the supply—sets in motion economic production.

But is this the case?

Why supply precedes demand? 

In the market economy, producers do not produce everything for their own consumption. Part of their production is used to exchange for the goods produced by others. This means that something is exchanged for something else. This also means that an increase in the production of goods and services sets in motion an increase in the demand for goods and services.

According to David Ricardo, 

No man produces but with a view to consume or sell, and he never sells but with an intention to purchase some other commodity, which may be immediately useful to him, or which may contribute to future production. By producing, then, he necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person.

Note that an individual’s demand is constrained by his ability to produce goods and services. The more goods and services that an individual can produce, the more goods and services he can demand (i.e., acquire).

Expanding savings key to economic growth

Without the expansion and the enhancement of the production structure, it is difficult to impossible to increase the supply of goods and services. The expansion and the enhancement of the infrastructure hinges on the expansion of saving (i.e., restriction of present consumption).

Savings are required in order to support individuals that are employed in the various stages of production. This includes individuals that are employed in the production of consumer goods. This also includes individuals that are employed in the enhancement and the expansion of the infrastructure. One cannot expand production and the productive structure without prior saving to provide for necessary consumption during the process. Hence, what matters for economic growth is not just tools, machinery, and labor, but also an adequate amount of saving to facilitate the expansion of capital goods.

Government is not wealth generator

Government “produces” goods and services that are low-priority for individuals. In fact, it can only inhibit or rearrange production. It cannot produce anything without an act of consumption. The government is not a wealth generator.

Various individuals who are employed by the government expect compensation for their work. One of the ways the government can pay them is by taxing true wealth-generators—those individuals generating goods and services demanded by consumers. By doing this, the government forces an exchange of less valuable goods and services (i.e., government-produced goods and services) for more valuable goods and services produced by wealth-producers. Consequently, this weakens the wealth-generating process and undermines economic growth. By taxing wealth-generators, the government forces them to exchange more for less.

An increase in the money supply as a result of the Fed’s lowering the interest rate sets in motion another exchange of nothing for something. This entails a weakening of the process of wealth generation. 

An important factor that makes fiscal and monetary policies appear to “work” is if production and savings are expanding, thereby providing sufficient support to wealth and non-wealth generating activities. If, however, savings is declining, then overall economic growth is going to follow suit. Moreover, the more government spends, and the more the central bank pumps, the more will be extracted from real wealth-generators, thereby weakening any prospect for genuine economic growth. According to Rothbard,

Since genuine demand only comes from the supply of products, and since the government is not productive, it follows that government spending cannot truly increase demand…

When expansionary monetary and fiscal policies divert wealth from productive agents that could have been saved, consumed, or invested, consequently, this hampers wealth, production, and capital accumulation. As the pace of expansionary policies intensifies, a situation could emerge where even existing capital cannot be maintained. As a result, the overall economy is impoverished through capital consumption.

Similarly, other wealth-generators, because of the increase in government outlays and monetary pumping, are going to have less savings at their disposal. This, in turn, further hampers the production of goods and services.

A decline in the inflationary growth-rate of the money supply and savings

An increase in the growth-rate of the money supply via inflation leads to an exchange of nothing for something. Hence, the increase in the inflationary growth-rate of the money supply undermines saving and capital investment, all other things being equal. Conversely, we can infer that a decline in the inflationary growth-rate of the money supply aids saving. 

A real increase in saving, all other things being equal, strengthens the process of wealth generation. Hence, a decline in the inflationary growth-rate of money supply supports real economic growth. Consequently, this can also provide support to the stock and bond markets because the increase of real savings lowers the individual time preferences, all other things being equal. This is what, on a free market, leads to lower interest rates.

A fall in the yearly growth rate of our monetary measure (AMS) from 79 percent in February 2021 to minus 6 percent by June 2023 provides support to the growth momentum of real savings. This, in turn, allowing for the time lag, should mitigate the economic slump. However, the expansionary monetary policy of the Fed is likely to undermine the process of wealth generation overall. The yearly growth-rate of AMS jumped from minus 6 percent in June 2023 to 6.2 percent by August 2024.

Conclusions 

It is quite likely that the sharp decline in the yearly growth-rate of money supply during February 2021 to June 2023 laid the foundation for increasing savings and genuine economic growth. The benefits of the decline in the money supply growth-rate on the economy are likely to be undermined by the artificial lowering of the policy rate by the Fed. The artificial lowering is going to generate the misallocation of savings. This will weaken economic growth. Fluctuations in interest rates should reflect the preferences of individuals and not the central bank bureaucrats.


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