Time value of money is no more

UPDATE 18/01/09 – here is a short post by Paul Krugman explaining some of the actual implications of zero interest rates.

Just about a week ago I wrote on debt and usury, stating that the time value of money is widely seen in the western world as a fundamental concept on which some of the most basic tenets of our economic and also social institutions are based. This is pretty much the first thing that one is taught at the beginning of a curriculum in economics – a dollar today is worth more than a dollar in the future, and this decline in value is compensated by interest.

Apparently this is no more – yesterday the US central bank lowered its base lending rate to zero, a dramatic move that is set to be followed by the Bank of England and other major central banks all over the world. Also, the language used in the press release deserves attention – basically it reiterates Bernanke’s recent pledge to ‘drop money from helicopters’ to stop the US economy falling into deflation. The “final cut” of interest rates is, however, a major milestone for several different reasons. Not only is it something unheard and -seen of, something virtually unthinkable just a year ago, this effectively also means that Federal Reserve has exhausted one of the main tools of a monetary policy – they simply can’t cut the lending rates any more, short of starting to actually pay people in order to make them borrow money. To be sure, they still do have other options but those are increasingly of intravenous kind – injecting the cash directly into the bloodstream of the economy. To quote the Economist – having run out of interest-rate bullets, the Fed has now fixed bayonets. And things are bound to get messy indeed.

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