Okay, another Econ question from me that I am puzzled about.
We’ve been hearing for a couple of weeks now how banks don’t have any liquidity. They’ve got so much toxic paper that they can’t/won’t lend money to anyone, not even each other. This is creating a credit crunch; businesses can’t borrow to expand, consumers can’t borrow for car purchases, mortgages are tight, etc.
Right. So today the FED lowers the target for the federal funds rate, the rate that banks lend to each other, from 2 percent to 1.5 percent. This will also lower interest rates throughout the economy in an indirect way. Here is what confuses me:
The problem was never that people didn’t want to borrow. Businesses and consumers would LOVE to borrow, but banks don’t want to/can’t lend. By lowering the funds rate, and by default the interest rate, won’t banks be even LESS likely to lend money now?
It seems to be, if I understand the problem, that the right response would have been to raise the federal funds rate so that a bank could see a greater return on loans, and be more likely to lend, loosening credit.
Where has my minor economic mind gone astray?