Rajan Plays Calvinball on Monetary Policy

Raghuram Rajan has a post on monetary policy and QE2 at Project Syndicate titled Money Magic (h/t Reihan Salam). A friend pointed out that post-crisis conservative economists talking about monetary policy in general, and QE2 specifically, is like watching a game of Calvinball – they appear to be making up the rules and the specifics of how to score points in the debate on the fly.

If I read this correctly, it’s an argument against monetary policy in general. Rajan:

Some Americans view Fed Chairman Ben Bernanke as a modern-day wizard, able to revive the economy through a swish of his monetary wand – first ultra-low interest rates, then quantitative easing, and perhaps eventually money-printing. If inflation is low, they want the Fed to use every spell it knows to revive the economy. Like the World War I generals who reacted to every slaughter of their men by sending even more over the top of their trenches in a vain attempt to overwhelm the enemy, “free money” types react with “More!” if their policy does not seem to be working.

More than any other policy action, monetary policy suffers from the sense that there is a free lunch to be had. Yet the interest rate is a price for the savings that are transferred to spenders. To the extent that the Fed manages to push this price down (and some economists will dispute its ability to push any meaningful interest rate down), it taxes the producers of savings and subsidizes the spenders of savings. Clearly, no government considers pushing down the price of any real good an effective way to stimulate the economy – any gain to consumers is a loss to producers, and the loss typically will outweigh the gain if the market price is a fair one. So why are savings different?…

A second view is that households are scared and saving too much – they need to be pushed into consuming by lowering the returns to savings. It is hard to imagine, though, that with the US household savings rate at about 5%, and with households severely indebted, they are saving too much. While it might be nice to get them to spend a little more now, and save more later, it is hard to engineer this easily….

Clearly, someone is paying a price for ultra-low interest rates: the patient and uncomplaining saver….

Here’s a thought exercise I encourage people to do when they dissect what people think about monetary policy at the zero bound, where we are now.  Imagine short-term interest rates were actually at 2% right now.  Somebody forgot to actually go ahead and push them down to zero. Whoops.  If you looked out at the economy, would you lower interest rates?  Given unemployment, inflation, off-trend GDP and all the other conditions of the economy, do you think the economy is heating up too fast or too slow?  If you would lower short-term interest rates at 2% now, which you probably should, why don’t you do it at zero, other than the fact that you can’t?

Rajan, who previously argued that there was something special about being at zero that made the market go sideways, apparently wouldn’t reduce the short-term rates given the state of the economy. Even worse, he’s gone from creating arguments that the zero-bound encourages too much speculation to a morality play.  There’s Ben Bernanke, a WWI general pushing soldiers over the trenches.  Inflation taxes producers and subsidizes spenders is the main result.  Would the phrase that inflation taxes hoarders, provides incentives to do transactions, relieves the debt burden of the past and balances the relationship between creditors and debtors (and debt and the entire economy) be equally acceptable?

There’s a reason people either look to employment and inflation or a level or inflation target to determine what is the best course of action in monetary policy.  It’s so that the goal of monetary policy is clear.  It’s not about rewarding the good people and punishing the wicked, it’s about stabilizing growth, prices and maximum employment without overheating the system or letting it choke to death from a lack of oxygen.  And it isn’t clear to me what rules or rough guidelines are motivating the argument here.  Hence, Calvinball.

We’ll have more on this next week, but as for severely indebted households, remember that QE kicked off a refinancing boom that was important for repairing balance sheets. As Joe Gagnon noted at the Roosevelt Institute’s Federal Reserve conference “one of the biggest goals of QEI was to push down the mortgage rate to spark a refinancing boom to encourage households and enable households to reduce their expenditures and repair their balance sheets and be able to spend again. That worked not quite as well as we hoped because the administration’s program for getting underwater borrowers to borrow didn’t work and I think that’s a true disaster that has no excuse.” Getting the GSEs to allow refinancing of underwater homes on more favorable terms would constitute another wave of immediate stimulus.

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14 Responses to Rajan Plays Calvinball on Monetary Policy

  1. Pingback: Monetary Calvinball - NYTimes.com

  2. Mike Easterly says:

    Rajan made the same point in his 2005 paper to the Fed’s Jackson Hole conference, so I don’t see it as Calvinball.
    This strikes me as the Greenspan Put all over again. Farhi and Tirole published a paper about six months ago about monetary policy and moral hazard — I’d be curious about your thoughts.

  3. JW Mason says:

    Wow, that’s a real stinker. The “patient uncomplaining saver” is a lovely bit of pro-rentier rhetoric, tho.

  4. Michael Turner says:

    “Some Americans view Fed Chairman Ben Bernanke as a modern-day wizard, able to revive the economy through a swish of his monetary wand…” Wow. Although Bernanke comments on fiscal stimulus only rarely, generally staying within his central banking bailiwick, he’s made it pretty clear that he believes rapid revival depends on fiscal stimulus, that the monetary channels can only do so much.

    • Michael Turner says:

      The more I look at this, the more dangerous it seems. “Fiscal stimulus didn’t work” enjoys great truthiness for people’s failure to analyze the counterfactual, and for their failure to look at how much was originally needed. And we’re not going to get much more fiscal stimulus. So “stimulus” begins to equate with “monetary dovishness” — which, in itself, isn’t going to be very effective. The natural conclusion will be “stimulus doesn’t work at all – it just racks up more debt.”

  5. Neildsmith says:

    I know you mean well. “Getting the GSEs to allow refinancing of underwater homes on more favorable terms would constitute another wave of immediate stimulus.”

    I don’t suppose you will also pay my rent for the next couple of months too. That would be stimulus. I’m really very sorry that many Americans bought over-priced, illiquid and depreciating assets thinking they were a great “investment”. I’m even more sorry that they took loans against short-term paper profits on those assets to buy really cool stuff that distorted our economy. And I’m really, really, sorry that not very many liberals (and no conservatives) thought any of this would end badly.

    But why oh why must we reward people who don’t need to sell their over-priced, illiquid, and depreciating houses with a reduction in rent. Because, really, they are just like me. Renters. And I didn’t get any really cool stuff when I signed my lease. So because I’m a good liberal, I am really sorry about all those things. But I will never support giving more free money to people who haven’t yet demonstrated an ability to manage their finances. That would make me a liberal fool.

    • ezra abrams says:

      yes, a lot of ordinary people did really, really stupid things (the NY Times , about a year ago, had this great piece where they went thru a cul de sac in california, house by house…)
      and ordinary people have paid: lost jobs, lost homes, broken marriages, kids ashamed to go to school because they are living in a motel, ….
      have the bankers paid ? (btw, if a person with no education is pursuaded by a banker to take out a a bad loan which is securitized by GS, who is more “responsible” the High School drop out or the Ivy League summa graduate working on wall street ?

  6. Mike says:


    I understand where you are coming from. But how does letting someone with an CLTV of 115, who is paying interest at 2006-07 rates, refinance with the same balance into the record low rates available right now, hurt you? People with a CLTV of, say, 80 are doing this all the time. This isn’t renegotiating the debt itself.

    The GSEs take on some credit risk but it is balanced by a consumer with more breathing room so I think the credit risk could easily balance out. But your argument seems more moralistic, and I don’t get that. Is paying interest at a higher rate than current rate the right punishment? In normal investments equityholder gets wiped out, and the “equity” any underwater homeowner had is gone.

    On a side note, insomuch as we have disinflation, people paying pre-crisis rates of interest are giving a massive subsidy to the financial sector if they can’t refinance into the current rate.

    • Neildsmith says:

      Thanks for replying. I have no doubt that the GSE’s could do what you describe if we made that policy decision. Cutting the interest rates on underwater mortgages will no doubt stimulate the economy. That is, I assume, what all those tax cuts have been doing. Are there lots of people out there paying 10% on a mortgage? If so, then they are even dumber than I thought they were. Otherwise you are talking about cutting the interest rate by one or two points. Really? Why bother. Let’s just keep giving tax cuts. At least then it goes to everyone.

      If it were any other asset we wouldn’t be having this discussion. Stocks bought on margin now underwater? Tough. My car is worth less than the day I bought it. Tough. Art, antiques… any other asset lost value? Tough. But because it is housing, suddenly it is different. Suddenly we care because… Why? Don’t tell me this isn’t about morals. Many people want to save these houses, not because of economics, but because it’s someone’s home. They feel bad for them. Now if you want to continue to make this argument on strictly economic terms, be my guest, but I won’t believe you. 🙂

      • guyboo says:


        Mike was correct that your argument is strictly a moral one. That’s not to say it’s bad, but it’s not relevant to a discussion of how to drive down unemployment and revive consumer demand. A massive car loan modification program (to say nothing of a program to shore up the value of that Stickley sideboard you bought at the antiques market) would not make a dent in consumer confidence nor provide the breathing room to homeowners who, through no fault of their own, have seen their illiquid assets dry up, and who are consequently now sitting on cash they might otheriwse have spent. The degree to which the health of the U.S. economy depends on the housing sector is clear from the severity of the crisis we’re in. That’s the main reason people are talking about the need for loan modification and criticizing Obama for the failure of HAMP. I don’t think it has much to do with bleeding hearts not wanting people turned out of their homes. I don’t want them turned out of their cars either, but it’s their houses (an my house, for that matter) that count when it comes to climbing out of this painfully long recession.

  7. The argument for low interest rates is that they will persuade firms to invest more. But that considers only the demand side of the equation. What about the supply side? Economists would agree almost unanimously that rent control reduces the quantity and quality of rental housing brought to the market. Why do they then find it hard to understand that low interest (the rent on money) discourages banks from lending? Low interest rates merely encourages banks (and individuals and institutions with spare cash) to engage in speculation.
    See http://www.philipji.com/item/2011-06-05/low-interest-rates-have-no-rationale-whatsoever

  8. MrM says:

    So, what about Ranjan’s original point, that the ZIRP punishes people who rely on fixed income to support themselves? One can call them rentiers, but it does include millions of retirees, whose investments in bond mutual funds are yielding nothing. Should they dig into principal? Cut their consumption?

  9. JW Mason says:

    the ZIRP punishes people who rely on fixed income to support themselves

    A more precise way of saying this is that people with a substantial amount of interest income benefit from higher interest rates. There’s nothing special about zero — if your income is coming from a bond fund, you always want interest rates to be higher. On the other hand, the vast majority of us who don’t get our income from bond funds, want interest rates to be lower. So who gets priority? Bondowners don’t want to dig into principal. People without jobs don’t want to stay unemployed. Somebody may have to get something they don’t want.

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