Zombie Firms smirk with Fed’s rate decision

Now that the Fed has sent the message that nominal rates will stay at the ZLB for a considerable time after October, let’s revisit the concept of the Zombie firm. The ZLB Fed rate makes it more likely that zombie firms will continue to limp on…

Zombie firms are not good for society. The main reason is that they are very resistant to raising wages, since they must control costs in order to cover their interest expense. They also lack the strength to grow well. They should either die off or be re-structured.

Moreover from (Time to end life support for zombie firms)…

“… they depress economic activity by making it difficult for healthy firms to grow rapidly, increase profits and investment, and create jobs. They also block start-ups with new technologies from entering the market. In a word, they impede the process of creative destruction.”

“As a result, the presence of zombie firms harms the productivity of an industry. If there is a large presence of zombie companies across industrial sectors, the economy as a whole will suffer. So weeding out zombies is essential to make the economy run efficiently.”

“However, this is easier said than done. In the first place, banks have little incentive to kill zombies off. Banks are required to keep their capital ratios high. If they stop providing support to hopeless companies and let them go belly up, they have to set aside more reserves to cover the loans extended to them. This weighs on their balance sheets and lowers their capital ratios.”

When demand is weak in an economy, zombie firms struggle more. But banks are in somewhat of a self-interest trap to maintain accommodative monetary policy to keep zombies alive.

Why do I say that zombies smirk with the Fed’s accommodative policy? Sydney Finkelstein gives us a clue into the attitude of these companies in his article, How to Spot a Zombie Company?

“Many of the executives of failed companies were not only arrogant—they were proud of it.”

Their arrogance is bad for society.

Bottom line: Even if you do not think there are lots of zombie firms in the US, there are zombie firms in Europe and other continents. Raising the Fed rate would have a global impact and go a long way to cleaning out the zombie firms so that the global economy could heal itself properly. However, that process gives worry to the balance sheets of banks and of triggering a recession. So there must be pressure within the banking system to keep the central bank rates low for a “considerable” time in order for society and banks to avoid suffering the hardships of killing zombies off.  Yet we will eventually have to kill them off in order to improve productivity and real wages. Sooner but for sure later the world will have to take its medicine by central banks tightening their rates…