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.