Does Expansionary Monetary Policy Primarily Benefit Finance and Rentiers?

[I’m moving blogs – check out the Next New Deal Rortybomb blog, here is the new rss feed, and here is this post over at the new site. I move over entirely Wednesday, and will cross post until then.]

Joe Weisenthal calls it the Biggest Myth in Monetary Policy Today, and recently there’s been a wave of posts about it.  Would another round of expansionary monetary policy at this point – in either a QE3, a conditional higher inflation target or NGDP targeting – primarily benefit the financial sector, rentiers and the wealthy?

Here are Daron Acemoglu and Simon Johnson at Economix, making the case in Who Captured the Fed?:

Thus was born the idea of independent central bankers, steering the monetary ship purely on the basis of disinterested, objective and scientific analysis. When inflation is too high, they are supposed to raise interest rates. When unemployment is too high, they should make it cheaper and easier to borrow, all the while working to make sure that inflation expectations remain under control.

Increasingly, however, it seems that technocratic policy-making is just a myth. We have come full circle, and the Wall Street banks are calling the shots again…

Monetary policy has an impact on inflation, output and employment. But it also has a major impact on stock market prices. Any central banker raising interest rates is reducing stock market values and thus eroding the bonuses of top bankers and other chief executives….

Those people will lobby, asserting that higher interest rates will undermine the economy and cause us to plummet into recession, or worse….

We have lost track of the number of research notes from major banks pleading for easier credit, lower capital requirements, delay in implementing financial reforms or all of the above…

As the American economy begins to improve, influential people in the financial sector will continue to talk about the need for a prolonged period of low interest rates. The Fed will listen.

I’m a huge fan of both Daron Acemoglu and Simon Johnson (I’m about to start each of their books, Why Nations Fail and White House Burning), so I want to take this argument carefully.  How to approach it?

First off, it isn’t just the financial sector calling for low rates (if they are, in fact, calling for it, as we’ll see in a second).  A generic Taylor Rule, as Paul Krugman recently pointed out, calls for low rates until 2015.  Mess with the rule and the data a bit to adjust that date at the margins, but generic macroeconomic stabilization rules still see low rates for quite some time as necessary.

I always find the following to be a useful thought exercise: imagine we wake up and find that interest rates aren’t set at zero but instead at one percent.  Whoops!  Should we turn around and have the Federal Reserve lower interest rates?  Those who think that Taylor Rule is correct and that the zero lower bound is blocking monetary policy from being effective would say yes; so would people who think the Federal Reserve isn’t out of ammunition at the zero lower bound, people like Christina Romer and Charles Evans.

The post argues the Federal Reserve should, when unemployment is high, “make it cheaper and easier to borrow, all the while working to make sure that inflation expectations remain under control.”  The post seems to concede that monetary policy works as normal, and unemployment is high and inflation expectations are, if anything, lower than what we want.

But I feel the entire vibe of the article is wrong. The financial sector is calling for higher interest rates.  This is why Carmen Reinhart told Institutional Investor that “Financial repression is manifesting itself right now” alongside the notion that financial repression is like “the rape and plunder of pension funds.”  Members of the financial community complain to reporters about “low interest rates that have been ‘artificially manipulated’ by the Federal Reserve.”

Or take Brad Delong’s six minute debate about QE with Jim Grant from last year.  As Delong summarized it (my bold):

I found it depressing because the major unfairness Grant focused on is that, because of the Federal Reserve, investors in money market funds can get only one basis point of interest. The 9% unemployed: they are not the victims. Those who cannot sell their houses because of the foreclosure overhang: they are not the victims. Those whose businesses crash because of slack aggregate demand call they are not the victims. The real victims are the rentiers who have a right to a nice solid well above inflation safe return, and from whom the Federal Reserve is stealing that right.

And I found what I could gauge of Jim Grant’s worldview depressing as well. He seemed to be selling rentier-populist ressentiment. Grant’s world is full of “takers”–and the Federal Reserve is helping them. And the biggest takers in Jim Grant’s mind are the hedge fund operators of Greenwich, Connecticut. Why are they the biggest takers? Because they can borrow cheap, at low interest rates, and put the money they borrow to work making fortunes. If only the Federal Reserve would shrink the money stock and raise interest rates! Then the hedge funds would have to pay healthy interest rates for their cash! Then the profits would flow to the truly worthy: the rentier coupon-clippers now suffering with their one basis point yields.

Never mind what a policy of monetary restraint to “normalize” interest rates would do to the unemployed…

You can read that in the recent statement by Mohamed A. El-Erian of Pimco, who, as Karl Smith noted, wants the Federal Reserve to focus on microeconomic goals instead of the macroeconomic problem of full employment.  This isn’t new.  As Keynes noted, “the most stable, and the least easily shifted, element in our contemporary economy has been hitherto, and may prove to be in future, the minimum rate of interest acceptable to the generality of wealth-owners.”

The implicit argument is that the interest rate compatible with full employment is too low for financial investors to accept.  Do we then just accept mass unemployment and the subsequent hysteresis-induced slowing of growth and human potential so Jim Grant and Pimco can make a profit they feel is worthy of their financial talents?  Of course not.

Now if you check out Jim Grant’s argument to Brad Delong, there’s an argument that we should split finance in two sectors – an established one that is hurt by low interest rates and one that is more focused on intermediation and/or trading for themselves, which could benefits from low rates and bubbles is stock prices and assets.

The stock market is following unemployment claims pretty closely, so it isn’t clear to me that the stock market is broken from its function as a prediction of future economic activity (i.e. in a bubble).  I like two MIT economists arguing that we should disconnect stock prices from the real economy, but I think that requires an additional layer of explanation.  For instance, if monetary policy was constant and we passed another round of deficit-funded fiscal stimulus to rebuild infrastructure and employ people, I would expect the stock market to increase because the economy would be stronger.

If that’s the case, that there’s two financial sectors and one of them benefits from monetary expansion we have to ask – so what?  If monetary policy is working, and bringing us closer to full employment, and some hedge funds and Wall Street traders make some money off of it, why should that impact our commitment to using all levers for full employment?  Monetary policy is not a morality play, and it’s not about rewarding the good people and punishing the bad ones.  It’s about stabilizing growth, prices and maximum employment without overheating the system or letting it choke to death from a lack of oxygen.

As Josh Mason’s great guest post here mentioned, if we are worried about where the financial sector channels money, that’s an argument for regulation instead of mass unemployment and scarce liquidity.  We should commit to better regulations as well as progressive taxes and/or financial taxes.  If those aren’t in place (and I don’t believe they sufficently are), those shouldn’t be attempted with monetary policy, and they absolutely must not distract us from taking our eye off the goal – full employment in the wake of the Great Recession.

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7 Responses to Does Expansionary Monetary Policy Primarily Benefit Finance and Rentiers?

  1. Frank says:

    I normally don’t leave critical comments when I agree with someone 95% of the time. But I’m really worried about this line of thought. One question: What if all the new liquidity gets plowed into energy-hogging McMansions, with profits mainly going to financiers, builders, and energy companies? Is that really a good social outcome? Doesn’t that just entrench their power to boss politicians around into more, socially useless waste?

    Are you really ready to go whole-hog “bury money in bottles, then dig it out” vulgar Keynesian on us? Because it seems to me that the long-term political and ecological devastation caused by entrenching the power of the extractive industries is far more troubling than the temporary dip in unemployment purchased by a scheme to finance financiers to finance….whatever. Sounds a lot more like the old Spencer (“gotta help my allies”) than the old (“let’s develop a consistent theory of political economy.”).

  2. Mike says:

    So my commitment is to full employment first and foremost, and I want to pull on the three levers we have to get there – fiscal stimulus, monetary stimulus, and debt restructuring – as hard as we can while they each have “ammo” and that is consistent without overheating the economy. I believe all three still have “ammo” at this point – it isn’t counterproductive to do them.

    I’m not sure what you mean by vulgar Keynesian here – but I think we should hire people to do socially productive things like (re)build schools and infrastructure. If we run out of them, I’m ok with burying bottles then digging them out (though I’m also cool with just giving people money in that case).

    We should distinguish micro from macro here – if we are concerned about, say, ecological consequences of energy extraction or inequality, that’s an argument for taxes and regulation, not an argument (in my book, others would disagree) for slower growth and less employment.

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  5. Bob Small says:

    Another thought item on the effect of high interest rates: You posted Mason’s research showing high real interest rates to be the cause of the private debt build up from 1980 on. Wouldn’t high real interest rates also explain the increase in the deficit and a large portion of income disparity?

  6. Richard Grabowski says:

    I can’t really agree with the arguments made here because they leave out too many factors. I simply do not buy nor have I ever bougnt into the idea that monetary policy can solve all problems. Historically the level of interest rates does not have the effect of either creating full employment or hurting employment. During the 70s employment was high, and interest rates were high, even when rates soared to almost 20% to reduce inflation. On the other hand, we have no better proof that low interest rates cannot by themselves produce employment then our current situation, nor has it done so in Japan where interest rates have been near zero for 2 decades.

    As the financial systems have evolved today, interest rates have even less effect directly on the overall economy. Clearly, the low interest rates of today, meant by the Fed to eliminate a liquidity problem and promote business/employment, has had almost no effect. This has occured principally becuase the banking system is not loaning money to either home purchasers or small businesses. And large business simply has no need to borrow – they are sitting on an extimated $2 Trillion in cash – why should they borrow money. In fact, why is anyone borrowing money? The simple fact is that the bulk of all funds being borrowed though the Fed are being invested directly into Treasury bonds and commodity speculation, not into mortgage loans or small business loans. Even regional banks have no interest in making loans to home buyers, refusing to make a loan unless it qualifies for transfer to Fannie or Freddie.

    This coincidence of events has been caused by multiple factors: 1. Low demand, both for loans and products/servoces; 2. high risk in making normal loans into the mortgage and small business market; 3. Very low taxes, which make it far more profitable and far less risky to buy government bonds or make highly leveraged speuclative investments when the investor can control the speculative market (as the big investment banks and hedge funds do today due to deregulation and lack of enforcement of existing laws).

    So while I appreciate the monetary argument being made, it does nothing to answer the questions that are foremost on most peoples minds. When will employment improve, when will the economy pick up, and when will the current risks in both the bond and stock market be reduced to acceptable levels?

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