When US economic growth rates were the envy of the world, Federal Reserve Chairman Alan Greenspan attained a mythical status like no central banker in history. Since its creation in 1913, the Federal Reserve has always had its share of critics on both the right, for its perceived illegitimacy, and the left, for its undemocratic character. But from 1995 until early this year, both sides seemed content with the institution.
Unfortunately, the US economy’s incipient recession has changed all of that. Since January of this year, the Federal Reserve has cut interest rates eight times and has injected over $100 billion of easy money into the capital markets through the purchase of securities. Yet, business investment has remained lifeless and a decline in housing starts and consumer spending threatens to throw the economy into a prolonged tailspin. Some estimates suggest that Gross Domestic Product (GDP) may decline by as much as 5 percent in the 4th quarter of this year.
The fruitlessness of the Fed’s loosening cycle should be a lesson to those who believe that prudent monetary policy can somehow drive economic growth, or immunize the economy from fiscal and regulatory foibles.
For most Americans, interest rates are of greatest concern when it comes to purchasing a home. When to buy, or when to refinance, are individual decisions based on reasonable expectations about mortgage rates because the interest rate determines the real price of the house. As any homeowner knows, a property’s list price can be less than a third of its actual cost after mortgage payments.
For businesses, interest rates play a similar role in decisions about new projects or capital investments, which are usually debt-financed because interest payments can be deducted for income tax purposes as a cost of business. But there is also an important distinction: Unlike consumers, businesses base decisions about investment – the appropriate quantity of assets or physical capital – on profit-maximizing considerations. While lower interest rates may lead a consumer to apply for a home equity loan to buy a new washing machine, businesses are only affected by interest rates cuts if they lower the cost of capital to a point where the expected revenue from the new physical asset exceeds its real cost.
In 2000, the White House Office of Economy Policy came out with a report that credited the “Internet and High-Tech Economy” with one-third of the nation’s economic growth since 1995. While much of the media attention for the “new economy” was devoted to dot-com start-ups and incalculable price-to-earnings ratios, the real story was the fundamental transformation underway in the nation’s telecommunications networks. Hundreds of billions in debt and equity investment went in to laying fiber optics, purchasing routers and servers, and upgrading cable and phone lines to carry the data packets of the Internet. Analysts predicted an insatiable appetite for bandwidth to carry the Internet’s data and interactive video and investors flocked in droves. But then, all of a sudden, everything came crashing down.
For those who never really understood the Internet economy, the crash seemed like a natural occurrence, and in the case of the dot-coms, it was. But the rest of the tech economy is in the midst of what George Gilder has described as a “classic socialist famine,” where people starve because government intrusion prevents adequate distribution. In this case, the famine is a product of Federal Communications Commission (FCC) regulation that caps the price telephone companies may charge competitors for high-speed Internet connections to homes and businesses below the actual cost of the connection. As a result, phone companies have been unwilling to invest in broadband, leaving the vast fiber optic maze of the Internet backbone underutilized.
These high-speed, or broadband, Internet connections are the lifeblood of the Internet economy. The lack of broadband connections harms the sales and development of Internet equipment, personal computers, and software. 2001 has marked the first ever decline in personal computer sales, as broadband-starved consumers have been reluctant to buy new computers that simply allow them to save their Word documents faster. The key to an economic resurgence is broadband content and features that excite consumers to purchase new hardware and software.
The limitations of interest rate cuts have become apparent: By capping revenues from broadband below its cost, the FCC has brought the Internet economy to a halt. The Fed may continue this loosening cycle, and that may be good for some parts of the economy, but rate cuts will not entice firms to make losing investments. It is time for Congress to step out of the Fed’s shadow to restore capital investment and economic growth by eliminating this senseless regulation of telephone companies.