The Counterfactual Case Against ZIRP

The ZIRP Debate

 

The long held debate is what would the US economy being doing without ZIRP by the Federal Reserve, would we be doing worse, about the same, or better? The other delineation in the argument is whether there is a cutoff point where ZIRP stopped being effective, if it was effective at some point, and where this line of demarcation should be in terms of one, two, three, four and subsequent years of zero percent interest rates.
 

2012-2014 Period

 

I will focus on the last three years as I will give the benefit of doubt that in some small way ZIRP served some initial benefit to the economy by helping heal banks’ balance sheets and filling the void from the massive deleveraging that manifested from the busting of the credit bubble and the subprime crisis that help fuel the housing and financial crash of 2007/ 2008. 

 

But even there the case can be made that the aforementioned collapse was the direct result of a poorly designed and shortsighted abnormally low interest rate policy in the Greenspan Era of the Federal Reserve. 

 

The argument can also be made that ZIRP in any form is just bad monetary policy, and that in the long run a complete flushing and cleansing of the financial system was necessary and beneficial to incentivize the right kind of investment strategies going forward. This system cleansing would pave the way to much more sustainable, solidly founded business principles which would serve as a better foundation for the next era of productive growth in the economy for decades to come in this country.

 

But for the sake of argument let us give in that to some degree ZIRP was beneficial to stabilizing the patient to use a medical analogy for at least for the first couple of years. But regarding the last three years I will argue that the economy would actually be more productive and be prepped for more robust genuinely sustainable growth if we had foregone the ZIRP strategy and normalized interest rates to be more in line with proper functioning financial principles which respect the value of money, and promote healthy financial transactions between parties. 

 

A Healthy Respect for the Value of Money

 

The ability to borrow at Zero Percent distorts and promotes unhealthy choices with regard to capital allocation. If capital was privatized no lender in their right mind would undervalue the importance of their function as a lender and just give their money away. In fact, the principal of individuals is to over value whatever resources they have in deals between parties, and having an abundance of capital wealth is no small resource, it is probably the most valuable resource in the world in a healthy functioning modern financial system.