It just isn't working. That old interest-rate medicine, delivered in a slow, intravenous drip, is no...
It just isn't working. That old interest-rate medicine, delivered in a slow, intravenous drip, is not sedating the patient.
What's scary, for anyone with even a soupcon of contrarian instinct, is that everyone seems to have adopted this view after five 25 basis points rate increases in the federal funds rate in nine months.
Even the spontaneous slowdown school has done a 180-degree turnaround. Not only is the Federal Reserve ineffective in slowing the US economy but its gradualist approach may actually be fueling the boom. Come again?
This is like the one or two yahoos on the Bank of Japan's monetary policy board who vote for higher interest rates to increase the interest income of pensioners.
One suspects that the folks advocating the impotent-policy view learned somewhere along the line that monetary policy operates with a lag of anywhere from six to 18 months. I have no idea what empirical study produced that axiom, but it is repeated often enough by Fed officials that they must think it's accurate.
Economists have underestimated the strength of the US economy for the last four years. It makes perfect sense that the degree of monetary restraint needed to derail the momentum will also be greater than people expected.
Why leap to the conclusion that interest rates don't/won't work? Remember all the warnings in the early 1990s that low interest rates weren't going to stimulate the economy?
The Federal funds rate was lowered from 9.875% to 3% in 24 separate moves. It stayed at 3% for 16 months from the end of 1992 to early 1994, to a chorus of cries that the Fed was "pushing on a string,'' which has something to do with that fallacious Keynesian notion of a liquidity trap
In fact, the 1990s boom may be more the doing of Alan Greenspan than either Ronald Reagan or Bill Clinton.
Another loopy idea making the rounds is that the gradual, well-anticipated rate increases are giving the economy a chance to acclimatise.
Better to use surprise or the shock effect to achieve the desired results. Expectations theory suggests that markets price in all available information immediately.
If markets expect a rate increase in the future, they will adjust interest rates accordingly today. Investment decisions will be based on expectations about the future cost of credit. Lenders will demand a higher loan rate now if they expect their borrowing costs to be higher in the future.
"It seems to me that if the rate increase is expected, it will operate sooner,'' says Bob Laurent, professor of economics and finance at the Stuart School of Business at the Illinois Institute of Technology.
"If it's unexpected, it will delay the response.'' Then there's the popular notion that the Treasury is working at cross purposes to the Fed by paying down debt, thereby lowering market interest rates, especially those in the 30-year sector.
One big credit customer steps back from the trough, and that's supposed to be stimulative to the overall economy? What's important is why rates are falling. The Treasury is borrowing less. It's a question of reduced demand for credit, at least from one entity.
"If the government decides to spend more, everyone would agree that it's expansionary," Laurent explains.
"Now the government is going to be borrowing and spending less, interest rates fall, and that's supposed to be stimulative? Ceteris paribus, it would have the effect of slowing the economy."
Is it just the economics profession that elects to make up such nonsense to explain something that doesn't appear to be working according to plan? Imagine if you went to a physician for elevated cholesterol levels, and the low-fat diet he prescribed didn't produce the desired result immediately. Would he recommend going back to a diet high in saturated fat?
Maybe if raising rates isn't working, the Fed should think about lowering them.
Caroline Baum is a Bloomberg reporter
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