It was one of the truly black days of economics when interest rates were decided to be gods by the monetarists. In eras of ultra-low, unnaturally low, interest rates, these principles obviously just don’t work.
Fed Chairman Ben Bernanke has tried hard, but will his new principles survive the markets?
This is a summary of the story so far according to Bloomberg:
The Fed adopted a three-part test for interest rates. Rates will stay low “at least as long” as the jobless rate remains above 6.5 percent; inflation between one and two years ahead is projected to be no more than 2.5 percent; and long-term inflation expectations remain “well anchored”—a code phrase meaning investors and consumers continue to trust that any big jump in prices is a blip, not a trend.
Nothing wrong with that at all- Until you consider the environment in which this policy has to operate.
The goals idea is good, no doubt about it. Scott Sumner, the person who suggested the goals is obviously no fool, and nor is Bernanke. The idea of having working parameters for a macroeconomic policy, in fact, can only be called a major improvement on the blank checks of the past. It should be standard practice.
The US employment market has the dynamics of a constipated rock. There is obviously no intent on the part of employers to hire in significant numbers. The current average of 220,000 could just as easily be ascribed to churnover as any other factor. Meaning interest rates will stay low for the foreseeable future.
The inflation rate is based on a dead mackerel of a consumer economy. Raising prices in this environment would be an own goal for businesses, and there’s no indication of much ability to absorb prices rises being left on Main Street. Meaning again that interest rates will stay low.
So far, status quo. Now add the markets to this equation:
If they don’t hire, they make more money thanks to low rates. In fact, compared to previous norms of rates far above current rates, they make a fortune. So they won’t hire.
In fact, they don’t need to do business at all. They can borrow low and invest overseas and make money on higher rates in places like Australia. This is the notorious disconnect between the money markets and Main Street. The markets have been merrily doing their own business and business investment of the kind that creates jobs is long since out of fashion. The progressive boom in derivatives coincided with the progressive demise of the job market. There were much easier ways to make money than start a business and employ people.
Financial products were conjured literally out of thin air to make this money. Deregulation made it impossible to seriously control the explosion of dud loans to other countries, and similar, purely financial practices with no real scrutiny at all. That was the whole idea of deregulation in the first place, as so many people said.
Regulators have caught a few, notably some of those responsible for the hideous municipal bond scams, but the industry as a whole is still rattling along doing deals, and deliberately not doing conventional business finance. This is the market in which Bernanke’s ideas have to work.
This is basically freeloading on low interest rates. The current US rates are the sort you lend to an idiot relative on the assumption that they can’t avoid making money with rates like that. They’re certainly making money, but who else is? Certainly not Main Street.
There’s another side or several here, too-
Historically higher rates generated a lot more economic activity than the low rates can. Business investment, in fact, was driven by repayment of higher rates. Victor Kiam, the promoter of “borrow and work your tail off for success” in the 80s, pointed out that those rates were a great incentive to really drive business initiatives.
US money can go offshore and simply stay there, making more money and avoiding tax. There’s an actual working incentive not to do business in the US. That’s exactly what’s happening, in trillions of dollars’ worth of capital that could practically rebuild America from the ground up.
I don’t think Ben Bernanke or Scott Sumner are wrong, just saddled with a perverse financial market which has been absolutely unresponsive to any form of national interest issues. No depth of national crisis has got through those thick skins, and there are no cow prods handy to add emphasis.
May I suggest an additional plank to the idea-
Rates remain low if business lending in core employment-related sectors improves.
OK, it’s not subtle, but the Fed could have room to move in terms of punitive rate rises for the freeloaders. If they’re going to continue doing so little to help the economy, why should they be rewarded with low rates?
The current rates are at rock bottom, literally. At 0% they actually cost money to lend. That’s charity, and the aid simply isn’t going where it needs to go. Holiday time should be over for the banks and Wall Street. No business, no cookies.
Might want to do something about that offshore capital, too. If it stays there, it’s another huge incentive to do nothing at the expense of the nation.
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