Why Don’t Commercial Bankers Understand the Interests of Their Class Fraction?

Commercial bankers, you see, are not rentiers. Rather, they are intermediaries. And they are intermediaries who find an economy in which interest rates are likely to kiss the zero lower bound a very difficult environment in which to operate.

Thus if I were a commercial banker working for or advising the Federal Reserve, I would think like this:

The interest rate on relatively safe loans is going to bounce around with the state of the business cycle, as the Federal Reserve leans one way or another and as speculators expect the Federal Reserve to keep leaning or to normalize. But there is a fixed point of reference: The average around which the interest rate on relatively safe loans will bounce around will be equal to the rate of real profit, minus the yield discount for relative safety, plus the expected inflation rate.

Commercial banks need a wedge of about 300 basis points between their cost of funds and the returns on the loans they make. They need this wedge in order to operate their networks of ATMs, keep open their branches, and pay for their administrative processes. Commercial banks cannot pay negative interest on deposits. And commercial banks really do not want to sock their depositors with unexpected fees: that is a way for a bank to become a much smaller bank relatively quickly.

That means that:

• either there has to be a wedge of at least 300 basis points between the nominal interest rate on the loan banks make and zero
• or the commercial banking business model does not work.

If the average interest rate is below zero, then banks banks have to reach for yield. They must thus get into the business of making risky loans–loans that they are not equipped to judge well, and are made into situations rife with adverse selection and moral hazard.

Thus Commercial banks have a hard time making their business model work when the Federal Reserve target and the market expected inflation rate is, say, 2% per year. They would have a much easier time making their business model work when the Federal Reserve target and the market expected inflation rate were 4% per year.

Now combine this insight with the mechanics of maintaining an inflation target: When the actual inflation rate is less than 4% per year, the Federal Reserve should–slightly paradoxically–lower interest rates in order to boost spending and so get the inflation rate back up. And conclude that the commercial bankers and their allies in the Federal Reserve–the 36 Class “A” banker directors of the regional Federal Reserve Banks, the 36 Class “B” non-banker directors of the regional Federal Reserve Banks who are chosen by member banks to “represent” labor, agriculture, consumers, etc., but who do so mostly in the breach, and the regional Federal Reserve Bank Presidents who come out of the banking sector–ought to be among the strongest advocates of not raising interest rates now, and the strongest advocates of raising the 2% per year inflation target to 4% per year.

They are not.

Why not? Perhaps it is just that they do not believe in the Fisher Effect–do not believe that the average level of nominal interest rates would be 200 basis points higher under a 4% per year inflation target than under a 2% per year target.

Any other candidate explanations?