The Limits of Monetary Policy

We have recently learned that, while the Fed can do what it wants with the safe rate of interest (formerly known as the "pure rate of interest") it can't do much about the TED spread. Why didn't anyone think of that before 2007 ?

(4) There is, finally, the difficulty discussed in section iv of Chapter 11, p. 144, in the way of bringing the effective rate of interest below a certain figure, which may prove important in an era of low interest-rates; namely the intermediate costs of bringing the borrower and the ultimate lender together, and the allowance for risk, especially for moral risk, which the lender requires over and above the pure rate of interest. As the pure rate of interest declines it does not follow that the allowances for expense and risk decline pari passu. Thus the rate of interest which the typical borrower has to pay may decline more slowly than the pure rate of interest, and may be incapable of being brought, by the methods of the existing banking and financial organisation, below a certain minimum figure. This is particularly important if the estimation of moral risk is appreciable. For where the risk is due to doubt in the mind of the lender concerning the honesty of the borrower, there is nothing in the mind of a borrower who does not intend to be dishonest to offset the resultant higher charge.

J. Maynard Keynes 1937