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.
Per today’s FOMC statement:
“The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated.”
https://www.cnbc.com/2019/07/31/july-federal-reserve-meeting-what-changed-in-the-new-fed-statement.html
May keep about $3.6T ( a bit heavy on treasuries) while before the great financial crisis it held $0 .87T. The taper ran about $50B per month.
An “A” on the article. A good read. My hands relaxed. Matt asked this quesyion:
“with the unemployment rate low and the economy growing, then what’s going to happen when a recession does hit?”
The same thing which always happens, people get laid off, marginal producers disappear, and labor wages drop. Maybe I misunderstood the question? Anyhoo, there is that 4% I was grousing about earlier as the typical target for inflation or at least I thought it was.
I receive E-Mails when The Big Picture raises posts. This just in:
Barry Ritholtz deems today’s FOMC as politically motivated.
I am not comfortable treating this economy to the low rate regime Greenspan had.
https://ritholtz.com/2019/07/todays-reckless-irresponsible-politically-motivated-fomc-rate-cut/
The most irreverent rate cut in the world
Hey, look ISLM and myself actually agree on something. Not only was it politically motivated, but the inflation increases this September and November/December as oil prices steady yry and the shale bulge eases, the Fed just doesn’t like the look. Now granted, if the UK does default, we will see the liquidations start in September as banks start writing down debt and that could cause a liquidity collapse driving down inflation. Then you have the global auto implosion in terms of financial pressure and its relation to the junk bond bubble in the US, which is more of a 2020 problem.
The Fed generally just likes to do nothing at this point and watch. It ability to effect the economy has gotten weak since 1980 because the end of the cold war made capital abundant in the US. Abundant capital generally creates low interest rates itself and lower rates don’t necessarily create growth. This Marx and Mises both agreed on, the 2 jews staring across the abyss of time. UK default is a global recession asap. European banks would be run on and it would infect US banks with credit slowdowns asap. The US junk bond bubble burst and its relation to a auto recession is the funner less destructive end game as it ends the expansion(and cuts off funding buybacks to the tech sector).
Bert,
Why go on about oil prices when energy is specifically excluded from the core PCE that the FOMC uses to assess inflation expectations?