Alice Rivlin has a wonderful speech about Fiscal & Monetary Policy in a Post-inflation World. Her basic point among many keen insights is that financial instability should be more of a priority now than inflation.
So low interest rates at least cause inequality/wealth concentration – if you can beat -2.0 percent returns, people throw money at you and you go all 0.01 percent on us with a startup that tests people’s teddy bear’s DNA online through an iPhone app.
That part should be clear enough. I am sure teddy bear DNA testing is quite important but it all seems a bit… Pet Rockish, doesn’t it?
Then if we read our Sumner, we learn that interest rates and the money supply don’t seem to have the relationship we’ve always thought. Turns out a drop in interest rates are not a signal to start being economic again. The light stays a blinding brilliant green and nobody’s moving.
Who knew?
And meanwhile, the “deflation” thing – it’s because … there’s not enough money of various varieties in circulation, right? Even though we’re seeing close to if not negative interest rates.
If there was only some way we could get more money in circulation. Why, that would be keen, wouldn’t it? I wonder… can we do something like that?
So what did we do last time… hmmm… oh, that’s right – we had a World War. Roughly ( we don’t even *know* really ) 4% of the world’s population died of unnatural causes in it.
I am sure it will be fine. We have the best working on it, don’t we?
Raising rates can actually cause more financial leverage though, that is a danger. 99-00 hikes say high.
See my comment on your previous thread @ March 19, 2015 4:56 am
You cannot consider policy changes in a vacuum – you have to consider the circumstances and other policy actions as well. I’m sorry you need to give up partial analysis and think in terms of whole systems.
Reason,
I saw your comment that long rates might fall. That is a concern of the Fed. However, they hope that a rise in short rates will boost the long rate. But that is not guaranteed like you point out.
I agree with you about thinking in terms of whole systems. My guiding principle for economics is based on homeostasis and optimizing social benefits. Homeostasis is a whole system dynamic with various components like temperature, pH and hormone levels.
When nominal interest rates are below where they should be considering slack, that tells you that the patient is sick, very sick. Just raising nominal rates causes problems globally and domestically. But then again, low rates is causing problems too. Like Janet Yellen and others say, the risk are asymmetric, that raising rates has more risk than holding them lower. That tells you that the patient is sick.
I remember a big strong woman who ran a farm by herself in Oregon. Whenever her back hurt, she would go out and work saying that the exercise made her back strong again… and then the pain would go away. Whenever my back aches, I do lots of situps and the pain goes away. Think of how many people would just lay in bed taking pain killers until the pain goes away. They actually get weaker.
We have an economy that is taking pain killers and does not want to work and get strong in the midst of its pain.
Raising the nominal rates is an act of disciplining the markets and exercising their strength. I do not want to see the economies continue to get weaker and weaker.
I say put the nominal rate where it needs to be and work through the pain. The economy will get stronger through time but you need to willing to work through the pain like the good-natured woman on that farm.
Think about it… in order to be pain-free in the long term, you need to go through short-term pain.
The economy is weak and sick and needs to get strong.
There are many doctors who would say that the patient needs to rest. Then there are doctors who say that the patient needs to do exercise.
Then there are doctors who say that a patient with poor blood circulation only needs to take some pills and not change their diet or do exercise. Yeah right… that is not good medicine.
Low nominal rates with slack disappearing is like giving medicine to a patient who does not want to make lifestyle changes. In the end, they will become dependent on the medicine.
To the extent that financial instability exists, it is because government has rushed to deregulate the financial industries.
The US Congress gutted regulation of the financial industries, including the repeal of Glass Steagall and forbidding the regulation of derivatives. The US Congress had passed Glass Steagall after the financial crisis which brought on the Great Depression. Chairman Alan Greenspan would later admit to ‘flaws’ in his assumptions but he never admits any guilt in lobbying Congress to preempt regulation of derivatives.
Our unelected masters, the US Supreme Court, gutted the usury laws at the state level with their MARQUETTE NAT. BANK v. FIRST OF OMAHA CORP ruling. They discovered a ‘flaw’ in the way USC 85 had been interpreted since its passage decades and decades before. Never mind that credit cards were not even dreamed of when the it became law. This is a quote from that ruling: “But the protection of state usury laws is an issue of legislative policy, and any plea to alter 85 to further that end is better addressed to the wisdom of Congress than to the judgment of this Court.” The Supremes use this logic to divorce themselves from the damage that they knew that they would cause. Wiser men would have maintained the status quo and forced the banks to lobby Congress to change the law.
See http://caselaw.lp.findlaw.com/scripts/getcase.pl?navby=case&court=us&vol=439&page=299
Every new financial innovation has been treated as an opportunity to overturn older laws or create newer more permissive ones.
Financial instability is not a flaw in our system, it is a feature. A feature that will be defended by the US Congress and the US Supreme Court.
Speculators feed on low interest rates.
The price per barrel of oil crept from about $35.55 in 2002 to $100.01 in 2008? That is an increase of a factor of 2.8 times in 6 years. (Inflation adjusted prices)
See: http://inflationdata.com/Inflation/Inflation_Rate/Historical_Oil_Prices_Table.asp
Year ——— Inflation adjusted ————-— Percent oil ————————-— Effective FED Funds Rate
——————2014 dollars——————— price increase ———————— Percent, from monthly
2002 ———— $29.92 ———————————————————————-——1.667
2003 ———— $35.55 ————————-— 18.817 ———————————— 1.128
2004 ———— $47.05 —————————- 32.349 ———————————— 1.349
2005 ———— $60.45 —————————- 28.480 ———————————— 3.213
2006 ———— $68.28 —————————- 12.953 ———————————— 4.964
2007 ———— $72.99 ————-—————- 6.898 ———————————— 5.019
2008 ———— $100.01 ————————– 37.019 ———————————— 1.928
So, when the Effective FED Funds Rate was low, oil prices rose faster, and vice-versa. Look at those percentage increases! I conclude that oil should never have been at $100 a barrel anyway.
The FED should raise interest rates now.
Just a question. If interest rates are the cost of borrowing or the earnings on savings why then are those rates not subject to market forces rather than Fed Reserve manipulation? Is the effort to control interest rates an attempt to deal with the symptoms of economic dysfunction rather than the underlying faults of an economy, our economy? How much of the need for the Fed to control rates is brought on by the distortion in wealth and earnings distribution in the economy? By focusing only on the symptoms of inflation/deflation is the Fed doing little more than protecting the distortions that exist by attempting to ameliorate the results of such economic distortions?
If wealth and earnings were more evenly, granted not perfectly, distributed would market forces of money supply and the needs for such supplies be more likely to set reasonable interest rates. Isn’t that what our economic gurus have always told us? Let the market prevail. Maybe there is a need to look more closely at the value received by the economy and its society from those who benefit from the distortion of wealth and earnings distribution. The market for great wealth and earnings may be too tightly controlled by too few people in their own self interest to allow for the invisible hand to act freely. Maybe those too few have tied the hands of the market place to their own advantage and continue to do so at the expense of the economy and the rest of society.
Twerking interest rates is no way to run a modern economy. Making more certain that the market is not under the undue control of the self serving would seem to have more wide spread and longer lasting good effect on an economy. Just a thought.
Hi Jack,
To have one institution set the base interest rats is a huge problem in Europe. I think eventually Europe will have to make big changes. But in the US, there is less trouble by having the Fed due to better mobility of resources and better fiscal transfers. However, there are still problems. Some regions and sectors of the economy would do better with separate interest rates. But then how would you make sure that all borrowing and lending took place in the same appropriate region?
It then comes down to each bank or financial intermediary responding to the market for each region and industry.
Thebmain purpose of the central bank is to make sure that the short-term real rate moves correctly with business cycle. Market forces may not understand that dynamic and create other distortions.
So in my opinion, the Fed is good. But it needs to get the short-term real rate correct.
reason
My Comment from another thread:
http://angrybearblog.strategydemo.com/2015/03/is-the-us-getting-addicted-to-extremely-low-interest-rates.html#comments
March 19, 2015 4:49 am
I think rates should be normalized. By changing the path of government spending and so increasing inflation expectations.
Edward your answer to my previous post makes no sense at all to me, and I hate the analogy. The economy is not like a body, and depressing it is the opposite of exercising it. What you are saying is more like, when the patient (with gastroenteritis) was healthy it was eating lots of meat. Let’s give it lots of meat to make it healthy again. See the problem?
Reason,
In the study of medicine, which I did, many conditions seem the same but require different treatments. For example, you may see 2 people who are depressed, One person needs to rest, and the other person needs to do exercise.
What I see is an economy with a lack of discipline. Standards have fallen across the board ultimately weakening its strength. So you have a patient that is weak from lack of discipline and a race to the bottom in wages and global competitiveness.
So then monetary policy has to become more and more accommodative so that marginal companies can survive. Low standards lead to a patient that cannot handle the discipline of normal rates. So people cry out for accommodative monetary policy.
However,the patient just gets weaker. Wages continue to race to the bottom.
So how do you heal the patient? You start disciplining the patient. The market has become immature. Discipline will raise the level of maturity.
I realize that I am talking in behavioral terms instead of economic terms, but the dynamics are economic. Overall, firms become more productive and wages increase with discipline.
You will see that as the Fed lowers their projected path of dots, wages will be even more suppressed. Then inflation pressures will be even weaker. Then there will be calls for even lower Fed rates. It is a spiral downward.
The key is to discipline the markets.
“What I see is an economy with a lack of discipline”
????
What makes you think that is the case? What are the vital signs suggesting that we need to shake out inefficient competitors (i.e. have more monopolists and monopsonists)? Is it excessive wage growth? Low rates of business and personal bankruptcy? Or is it the lack of foreign competition as indicated by the high trade surplus?
I read what you are saying and I think of Paul Krugman quipping that the beatings need to continue until the patient cheers up.
I agree with her. Monetary policy should focus on the wild beasts of the economy, not the domesticated pets. Inflation is not the wild beast it was before the 80’s. It is a domesticated pet now, not likely to run away.
The wild beasts are now financial instability and the growing power of capital. The Fed should put financial instability as a priority above inflation in their mandate. She does not recommend that the Fed raise interest rates, but something needs to be done.
Alice Rivlin…
“But suppose that the major advanced economies actually face a new “normal,” in which inflation is low on the list of threats. In this new world the top-of the-list threats to prosperity in large advance economies are financial instability, slow growth with tendencies to deflation, and the concentration of income, wealth and political power in the hands of a small number of people”
“Financial instability in the advanced economies is a far greater threat to world prosperity than the risk that inflation could get out of control. Unfortunately, if central banks keep interest rates low enough for a slow growth world, they risk creating asset price bubbles based on cheap credit that can end in financial catastrophe. Raising rates is not the right response to containing asset price bubbles or avoiding financial meltdown.”
She does contradict herself a bit here by saying that while low interest rates risk financial instability, raising rates is not the response. She prefers other tools, but those other tools are not working.
“An array of sharper tools is needed. Dodd-Frank was an attempt to create those sharper tools, but, like all major legislation, it was an elaborate compromise among multiple stakeholders. We are still a long way from agreement on how the tools should work and how to use them. The hydra-headed financial regulation structure that survived the crisis has not demonstrated an ability to work effectively together.”
So the Fed may be left with raising rates as the most effective tool to control the wild beast of financial instability.