Here's a hypothesis that might inspire some economists to do some thinking (if only to get published somewhere):
The Fed has stated that its expansionary monetary policy will continue until inflation and unemployment reach the targets of 2.5 and 6.5 percent respectively. This statement has given businesses the expectation that price inflation will stop monetary expansion and dampen our already struggling economy. Directly or indirectly due to this expectation, businesses have restrained prices and constrained expansion and hiring, which in turn maintains expansionary monetary policy, creating a kind of vicious circle. Unused profits are stockpiled and invested, alongside the speculative funds of financial-capital investors who have easy access to bank loans at Fed-controlled super-low rates, in relatively liquid assets such as stocks, regular bonds, junk bonds, and a variety of other vehicles where cash can find an above average short-term return. Thus as a direct result of business pricing restraints, surplus money supply in circulation (i.e. that amount over the amount required to clear the marketplace) surfaces not in the usual spot (the general price level) but rather in a variety of asset bubbles. These bubbles will, by definition, burst; and given the ephemeral and quasi-arbitrary nature of the psychological drivers behind expectations, the bursting point will be reached suddenly and unexpectedly, when the marketplace perceives that the Fed is going to reverse its expansionary policy.
- In the long-term historical past, increases in money supply over the amount necessary to clear the marketplace have tended to cause an increase in the general price level.
- The Federal Reserve has increased the dollar supply dramatically since the crisis. (See this chart from the St. Louis Fed.) Confirmed by Professor Walker Todd at the American Institute for Economic Research, the monetary base is now at least three times the amount it was at the start of the crisis in 2008. About two-thirds of this is tied up in bank reserves, but the rest is somewhere in the economy. Yet the price level remains tame relative to its historical pattern.
- The American stock market indices, U.S. bonds, junk bonds, and other types of financial investments are at their all-time high, while in contrast the rest of the economy remains relatively stagnant.
- Farmland prices have doubled over a period of six or seven years and are probably in a bubble. (See the data and the farmer's rationale for making these irrational investments in this article by Blake Hurst, a Missouri farmer.)
- Businesses are acutely aware of the Fed's intentions, and Fed-watching has become an integral part of their forward planning.
- American businesses are stockpiling profits in preference to expanding and hiring. (See this fascinating report (pdf) from the St. Louis Fed. Of course, given the source, the report doesn't even hint at the possibility that the Fed's monetary gymnastics might be responsible for the stockpiling.)
- The marketplace has now had a century of experience with central bank interference in the money markets.
- The number of Americans who are unemployed but willing to work is at a peak; and the imbalance in the labor market allows wages to remain stagnant, or even to decrease in real terms, and helps businesses restrain prices. (See Shadowstats chart on unemployment; see also this piece at TheNewAmerican.com.)
- Excess money supply historically has caused the general price level to increase; but after a century of experience with central banks interfering with the money supply, businesses are now just as attentive to signals from the central bank as they are to supply and demand. The current trend being towards monetary instability, any excess money supply creates asset bubbles rather than causing a general rise in the price level. In other words, central banks exaggerate the business cycle, rather than attenuating it as they were intended to do.
- Other factors may contribute to businesses' hesitancy to expand (e.g.,"Regime Uncertainty" as Robert Higgs of the Independent Institute calls it; our current political inability to resolve the U.S. debt situation; global competition and trade shifting; uncertainty about future taxes, healthcare costs, and the international purchasing power of the dollar; the European crisis; the fragility of America's own banking sector; and let's see, what else?). However, the Fed's own policies may be playing a crucial role in our current economic stagnation.
I hope some enterprising economist will be inspired to do some research on this. (Wish I could do it myself, but I'm just a gadfly.)