Ben Bernanke takes on Walter Bagehot and Albert Einstein

In announcing that the Fed will continue to engage in quantitative easing and, by definition, zero interest rate policies until employment picks up, Ben Bernanke has taken on Walter Bagehot and Albert Einstein.

Regular readers know that your humble blogger thinks that monetary policy is essentially impotent when it comes to dealing with a bank solvency led financial crisis.  It is able to buy some time at an extraordinarily high cost, but it is unable to solve the underlying problem.

Further, regular readers know that Walter Bagehot observed that interest rates should never be less than 2% as rates less than 2% bring about changes in behavior that result in economic headwinds.

Today, we can see examples of these changes in behavior and resulting economic headwinds everywhere.

One just has to look at the pension fund death spiral where to meet their obligations to pensioners, companies are covering the shortfall in the pension fund's investment returns by taking money that could have been reinvested in growing the business and injecting it instead into the pension funds.

Or one could look at a Duke University survey of CFOs and see that businesses no longer change their spending if interest rates are pushed lower or higher.  Only an increase in demand would bring about more business spending and this spending would occur even if interest rates were higher.

Or one could look at retirees who are following my father-in-law's spending rule: tell me how much I can spend based on earnings from my investments and social security and I will only spend that amount.  The result is retirees cutting back on current consumption as their fixed income securities earn less.  They would rather cut back on current consumption then spending their life savings as they know the savings cannot be replaced and they fear something might happen where they need the savings.

Or one can look at workers who now face having to save 8x their current income by retirement and realize that the only way to achieve this even if they had previously been saving is by slashing current consumption and working till their 70.  By not retiring earlier, these workers also make it harder for younger people to find jobs.

Regular readers know that Albert Einstein defined insanity as doing the same thing over and over again and expecting a different result.

Zero interest rates and quantitative easing has been tried in Japan for over 2 decades and Japan does not have fantastic economic growth, but rather an economy that is struggling.

Zero interest rates have been tried in the US for four years and the economy is struggling.

Quantitative easing has been tried twice before and the economy is still struggling.

The reason zero interest rates and quantitative easing don't work is the changes in behavior and economic headwinds that result predicted by Walter Bagehot.  Making quantitative easing permanent doesn't reverse the changes in behavior or resulting economic headwinds.  It simply reinforces these changes and economic headwinds.