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Janet Yellen, the new Fed Chairman, recently spoke about her decision to continue low interest rates, calling the policy “beneficial.” As the WSJ noted, Yellen described how she seeks to assure the markets:

“By keeping interest rates low, we are trying to make homes more affordable and revive the housing market,” she said. “We are trying to make it cheaper for businesses to build, expand and hire. We are trying to lower the costs of buying a car that can carry a worker to a new job and kids to school, and our policies are also spurring the revival of the auto industry.”

The problem with Yellen’s approach to the economy is that she completely misunderstands how interest rates affect the economy, an incredulous thing considering that she is the Fed Chairman.

When Yellen describes the benefits of low interest rates, she gives several reasons for them: homeownership, business growth, and car prices. However, the real estate market and auto industries are actually doing fine, and businesses are not using low interest rates to borrow to hire.

The crux of the problem is that all of Yellen’s examples analyze the economy from a consumption perspective. While consumption does affect the economy, it is not nearly a powerful a stimulant as investment. Any basic economics course will tell you that.
The real reason for the continued sluggishness is that investors are prevented from earning any real and considerable income when interest rates remain low. When investors don’t see a decent return on investment (ROI), they stop investing.

What else? Couple the investment problem with the administration’s policies that hurt growth such as burdensome regulations, minimum wage increases, food stamp usage, and Unemployment Insurance extensions, and you have a recovery that is best described as tepid.

Yellen should know better than to appeal to emotion rather than basic economics when making her Fed decisions. The choice to continue low interest rates for at least another year guarantees an anaemic economy for the foreseeable future.