Thursday, August 12, 2010

Loanable Funds Fallacy

This is why I'm pretty pessimistic about effectiveness of Fed action. Yves Smith:

Can you see why this won’t work? The Fed’s implicit reasoning is that the BoJ didn’t shove money into the banking system in a way that would lead businesses to borrow, but the Fed has a better mousetrap. Huh? This is the loanable funds fallacy, that if you make money cheap enough, firms will borrow and invest.

But the cost of money is only one factor in a business’s decision to expand, and outside of financial firms, it’s typically a constraint, not a spur. If you run a dry cleaner, are you going to say, “Gee, my borrowing rate went down a point, I think I’ll open that new store”? The fall in the cost of money would change your action only if it was a critical factor, at the margin, and had restricted you. And for the vast majority of enterprises, the decision of whether to grow or not is based first and foremost on their reading of the environment, which includes the strength of the market for their services, the likelihood of competitor response, whether there are steps they can take to alleviate risk, like securing commitments from prospective customers or tying up critical technology or vendors.

The banksters like cheap money. They can bring it to the casino. It doesn't mean they have a desire to lend it, or that the rest of us want to expand our capacity to build widgets that no one has any money to buy.