On Yglesias on the Dramatic 0.25% Rate Cut

Monetary policy is roughly the only issue on which I regularly disagree with Matt Yglesias. So it is boring to note that I agree with almost everything he wrote in his Vox article on the recently announced 0.25% Federal Funds target rate cut.

His main assertions are:
– it is a very reasonable move even though Trump advocated it and it will help Trump’s 2020 campaign.
– The previous stance of normalizing interest rates because normal interest rates are normal made no sense
– The argument that higher interest rates are good because there is more room to cut interest rates if there is a recession makes no sense.
– It is too bad that it sure looks as if the Fed Open Market Committee (FOMC) bowed to pressure, but it is not worth doing something stupid just to prove your independence.

As I said, I agree with all of that. There is no reason not to cut interest rates if inflation is persistently below target (also I think the target should be 4% not 2% because that would actually leave more room to cut real interest rates if there is a recession).

I do have three criticisms. One is he praises Trump’s asseesment that interest rates were too high starting January 20 2017. Come on. Trump said they were much too low until November 8 2016. He knows what is good for Trump in the short run. Pretending he has any views on economics except that anything bad for foreigners is good for the USA and therefore good is silly.

The second is he does not explain correctly how interest rates affect demand. He wrote ” Lower rates mean it’s cheaper to finance investments in home renovations, business equipment, and other expensive durable goods. ” The word “equipment” is particularly silly. In fact, the user cost of equipment is mostly depreciation (now at least mostly due to technological obsolescence). If the price of your equipment declines by 30% a year (like the price of the laptop on which I type) an additional 0.25% a year of interest is almost entirely irrelevant. In fact, non residential fixed capital investment barely responds to interest rates except through the effect of interest rates on final demand which affects the return on capital and free cash flows.

Nor are home improvements all that important. The main channel of the transmission of monetary policy is through the mortgage interest rate which affects house sales and house prices which affects construction of new houses. Krugman (as usual) explained this very well. The data speak clearly.

Finally, he said QE was ended because it was fiercely criticized as likely to cause hyperinflation. It was, but the fact that, after QE1 during the financial crisis, further QE had no detectable effects on much of anything might have had something to do with it. It remains an article of faith to him that monetary policy is very important also at the zero lower bound. But the data speak clearly about that too.

Still I 99% agree with him on current monetary policy and I’m glad to get to 99.999999% agreement overall.

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