The year was 1979 and the rock band Pink Floyd had just released their concept album The Wall. Strains of Young Lust and Another Brick in the Wall filled the halls in my high school. These are fine songs (who can argue with lyrics like “How can you have any pudding if you don’t eat your meat!”?) but the song that really spoke to me was Comfortably Numb.
It emotionally resonated with me because beneath its seemingly depressing façade was a defiant and cautionary tale of the price that’s ultimately paid by numbing the pain rather than rising up against it and fixing the root malady.
I’ve always kept that message, if not exactly that song, near and dear to my heart. Bodily pain is the nervous system’s way of telling you something is wrong and numbing the body, except in the case of corrective action like surgery, is a foolish thing to do. By masking those important signals, you are tricked into thinking things are fine until catastrophe hits and a serious problem has now become an insurmountable problem. Tell most anyone in our wellness-conscious society and you’ll get a quick agreement – at least where the body is concerned.
The situation is quite different when it comes to the economic pain and, for reasons I can’t explain, very few people seem to know or care about the numbness that is killing our economy. And what is this anesthesia that is causing the numbness – the policy of the Federal Reserve to keep interest rates, specifically the discount rate, at zero.
In order to understand how low interest rates is acting to numb the economy, I need to say a little about prices.
In an economy, prices serve three purposes:
- Terms of the exchange for completing a transaction
- Signal to the producer about the relative worth of a good or service as judged by the consumer
- Signal to the consumer about the relative worth of a good or service as judged by the producer
When you go to a store and wish to purchase a good the deciding factor is the price. Measured relative to your want or need, the price determines whether the transaction is made and you leave the store with the item or the transaction remains unfulfilled and the good remains on the shelf.
Looked at locally, within the confines of a single consumer, the price simply serves to help determine the relative worth of the good to the consumer. Taken globally, each successful transaction sends a message from the consumer to the producer that the relative worth of the good is favorable to the consumer. Each failed transaction sends the opposite message, telling the producer that the good is valued too high. The speed with which the good is purchased sends a message about whether the price is too low or too high.
Likewise, each price set by the producer sends a message to the consumer about how the producer judges the worth of the good against the producer’s outlay in its production. If the producer can’t entice a consumer to buy the product for more than it cost the producer to make it then the message is sent that the producer should stop making the product.
In effect, the price system functions as the nervous system in the economy, sending messages to and fro between different parts of the body politic saying to either make more or less of a particular good. Seen in this way, prices help regulate the economy so that the scarce resources available to society are best used – where best is judged by consumer demand.
When the Federal Reserve keeps interest rates low, it basically floods the economy with an anesthetic that interferes with the signals sent using the price system. Businesses that should have received the message that they are not producing products desirable to society are instead receiving a mixed or muted message that tells them to try again.
By keeping interest rates too low, the Fed allows businesses that should have failed to remain on life support with what is essentially free money. The idea that the Fed has is that it is compassionate to keep business going; that in order for the economy to grow, businesses need to succeed.
But why? What’s wrong with failure as a message? In the body, pain speaks volumes. It tells the body not to do whatever caused the pain. Learning from the pain is not the same as preventing it entirely, for without the pain no growth can occur. How can our economy grow if we can’t learn what works and, more importantly, what doesn’t?
Maybe the Federal Reserve should analyze less, interfere with the economy for less often, and listen to some Pink Floyd instead.