The Arguments Being Put Forward for Raising Interest Rates Now Are Very Weak Indeed
The arguments for raising interest rates right now are of appallingly low-quality.
Consider, for example, Bloomberg View:
: Why the Fed Should Raise Rates Now: “Although the Fed hasn’t raised interest rates in almost 10 years…
…sympathetic pundits say it’s still too soon to raise them…. How did our financial system weaken to the point where a quarter of a percent increase in rates is more than it can handle?
Stop right there: it is not that “our financial system [is] weaken[ed] to the point where a quarter of a percent increase in rates is more than it can handle”. No interest-rate dove says it is. The reason interest-rate doves oppose rate increases right now is not that the financial system cannot handle them, but that they come with a cost–lower employment and slower growth–and no compensating gain in the form of an appropriate curbing of excess inflationary pressures, since there are no excess inflationary pressures visible either her and now or as far out as the horizon we can see.
The process started… when Alan Greenspan… lower[ed interest] rates to 1 percent… then… tighten[ed] policy… with agonizing slowness… set[ting] the table for the subprime housing debt mess…
Suppose, for the sake of argument, that Greenspan were to have pushed the short-term safe interest rate 200 basis points below its “proper” level–whatever that is–and kept it there for three years. By how much would that have boosted the amount that a subprime borrower could have paid for a house? The answer is simple: 2% x 3 = 6%. Even if you buy that Greenspan made an error in monetary policy in the mid-2000s, it accounts for only one-tenth of the runup in housing prices. And it accounts for a correspondingly-small share of the “subprime housing debt mess”. Greenspan’s policy errors were mighty–but they were all in the arena of lax supervision of lending standards and lending fraud. Bernanke’s policy errors were mighty–but they were all in the area of not cleaning up the supervision-and-fraud mess and not understanding the seriousness of the situation he was handed.
We’re likely to see a serious correction in the U.S. equity market… trigger[ed by]… hundreds of billions of dollars worth of bad debt in the energy sector… made to finance the fracking frenzy…. Perhaps the most disturbing statistic is that American corporations have announced dividends and share buybacks for this year that total more than a trillion dollars… at the expense of long-term capital investment…. Another area for concern is the burgeoning private market for investments, where companies are finding it relatively easy to raise capital…. The Fed has to finally take away the punch bowl. The economy may not be in top shape, but it’s strong enough to handle an equity correction of 20 percent to 25 percent…. Another mild recession would not be the end of the world…. Writedowns can be painful, but they instill a sense of responsibility…. Lift[ing] overnight rates back up to the 2.5 percent range years ago… would generate at least a trillion dollars annually, if not more, for [short-duration] fixed-income investors–and a possible boost of 6 percent to GDP…
Ummm… The purpose of raising interest rates is to shrink the economy, not grow it by “6 percent” or some other imaginary number pulled out of the air without any analysis. The extra trillion a year of income to short-duration fixed-income investors is offset by a ten-trillion loss to the portfolios of long-duration fixed income investors, plus an extra trillion dollars a year of payments by enterprising and consuming borrowers to rentiers.
So when Brooks writes:
So let’s end the era of the “Greenspan put” and Bernanke’s quantitative easing, and return to basics…
I, speaking as a Brad, find myself completely and totally humiliated by the low quality of these arguments.
The “basics” are that the Federal Reserve (i) engages in prudential regulation to curb the growth of systemic risk and reduce fraud, and (ii) sets interest rates so that planned investment is equal to desired savings at full employment and there are neither unanticipated inflationary or deflationary pressures on the economy. Labor-market indicators are confusing: the unemployment rate suggests that deflationary pressures are now gone, while the prime-age labor-force participation rate suggests deflationary pressures are still here. Inflation indicators are not confusing: inflationary pressures aren’t here, and aren’t expected to emerge in the near future. Financial asset prices suggest an overheated economy if the Federal Reserve is about to embark on a full tightening cycle, but are justifiably high if the new normal is one of Summers’s “secular stagnation” or Bernanke’s global savings glut. High financial asset prices do indeed raise the risks from lax macroprudential supervision. But why isn’t the appropriate policy response to make sure that macroprudential supervision is not lax?