After cutting the base rate for overnight lending – the fed funds rate – to zero, the majority of the committee decided to expand the money supply by purchasing MBS, notes and bonds. When we buy something in the marketplace, we pay for it, and this has resulted in significant liquidity floating about the U.S. economy, much of it going unused. As mentioned earlier, $ trillion of excess reserves from private banks is on deposit in the 12 Federal Reserve Banks, where it earns a paltry 0.25 percent, rather than being lent to job-creating businesses at rates bankers would prefer. Additionally, some $ trillion of excess cash is parked on corporate balance sheets – above and beyond the operating cash flow needs of the business sector – and copious amounts of cash are lying fallow in the pockets of nondepository financial institutions, such as private equity and other investment funds. A running discussion in the marketplace centers around whether the FOMC will decide to engage in further quantitative easing, especially given the most recent economic weakness in the U.S., against the backdrop of the well-known problems in Europe and slower growth in China and other “emerging” economies. I shall turn to that in a few moments. First, I want to go back to the 12 Federal Reserve Banks. Different growth patterns in the 12 Federal Reserve districts Here is a map of the 12 Federal Reserve Bank districts.
In this context I define the “new economy” as an increase in the potential growth of the economy. In the last few years, the growth of the American economy has surpassed most forecasts. Not only has the rate of growth been high in historic terms during the present upswing - around 3.5% per year on average since the end of 1991 - it has besides been very stable and unusually long lasting. At the same time, unemployment has fallen to near 4%; levels this low have not been witnessed since the 1960s. However, in distinction to previous booms, there has been no increase in the rate of inflation and the underlying rate of inflation has been more than halved since 1991, from over 4% to 2%. Public finances have improved considerably, from a deficit of 5% of GNP in 1991 to an expected surplus of around 1% this year. Looking at productivity per hour worked in American business, which is perhaps the best measure of how good a country’s growth potential is in the longer term, this has risen sharply, by over 2.5% on average since 1997; this figure can be compared with an average growth of productivity of around 1.5% over the period 1974-96. A substantial part of the improved productivity of labour can be explained by very high investments - so-called “capital deepening” - not least in computer equipment. In spite of the fact that unemployment has continued to fall throughout the period, the growth of productivity has been impressively high.