Interest rates: high? low? how the hell would Alan know? [update 2]

Eric Crampton noticed a little, shall we say, inconsistency from His Alan-ness of the Reserve Bank:

A week ago the RBNZ berated banks for interest rates being too high; today, Bollard berates consumers for responding to interest rates being too low. Which is it?

Well, how the hell would Alan know?  It sure as hell beats his pair of jacks.  Fact is, without a real market, how would anyone?  The problem is not just with our local Reserve Bank Governor – the problem is universal. As Jesus Huerta de Soto points out in his book Money, Bank Credit & Economic Cycles,

     the theorem of the economic impossibility of socialism, which the Austrian economists Ludwig von Mises and Friedrich A. Hayek discovered, is fully applicable to central banks in general, and to the Federal Reserve . . . in particular. According to this theorem, it is impossible to organize society, in terms of economics, based on coercive commands issued by a planning agency, since such a body can never obtain the information it needs to infuse its commands with a coordinating nature.
    Indeed, nothing is more dangerous than to . . . [believe] oneself omniscient or at least wise and powerful enough to be able to keep the most suitable monetary policy fine-tuned at all times.

So without a real market for money, we can never know what the 'real ‘price’ of money, i.e., the interest rate, should be.

What we do know however, but only after the fact, is when the central banks get it wrong.  For instance, “the relative price stability experienced under Greenspan” was not a good thing -- summarises Peter Boettke, it “is actually problematic, rather than a sign of the perfection of central banking practice.  During this period of time, the US realized tremendous productivity increases due to technological innovations, and also new trading opportunities in China and India.”  What we should have seen with those tremendous productivity increases was not “stable prices,” but gently declining prices. As Huerta de Soto writes:

The absence of a healthy "deflation" in the prices of consumer goods in a period of such considerable growth in productivity as that of recent years provides the main evidence that the monetary shock has seriously disturbed the economic process.

In short, the central banks don’t know what interest rates should be when things are bad (high? low? how the hell would they know?); but neither do they know what the hell they’re doing when things are going “well.” 

And when they get it wrong, and keep right on getting it wrong, we all suffer.

UPDATE 1: Just to make the point more plain: the pursuit of so called “price stability” (which generally involves a fair degree of meddling with CPI definitions) provides neither an anti-inflationary panacea (particularly not when housing prices are booming at a time of so-called stability) nor a guide to interest rate levels. M.A. Abrams makes the point clearer:

    In an economically progressive community (that is, one where the real costs
of production per unit are falling and output per head is increasing), any
additions to the supply of money in order to prevent falling prices will be
hidden inflation; and in a retrogressive community, (that is, one where output
per head is diminishing and real costs of production are rising), any
contraction of the supply of money in order to prevent rising prices will be
hidden deflation. Inflation and deflation can occur just as well behind a stable
price level as when the price level is rising and falling.

It rather puts several current controversies (inflation or deflation? rates up or rates down?) into perspective, don’t you think?

UPDATE 2: From the farting-against-thunder file comes this research from Canada’s Sprott Asset Management on the massive US budget deficit and bond issuance problem, which Bernard Hickey reckons is “a must read.”

It says global interest rates will rise [anyway] as the US nears default on its debt. Sprott says there isn’t enough money in the world to pay for the US deficits and its looming Medicare and Social Security crisis as baby boomers retire. . .

• “…the future solvency of the United States as a nation state is currently in jeopardy [says Sprott]. It is in far deeper trouble than the mainstream press cares to admit. There are simply not enough new buyers of debt on this planet to support the spending programs of the United States government - and it appears that current holders of debt are beginning to sell. Because it is impossible to balance the budget from outside sources of capital, the only source of funds left for the US, in all reality, is continued money printing. The Federal Reserve’s policy of Quantitative Easing is failing. The US budget is ludicrous, spending is out of control, spending promises are out of control, the world knows it - and we know it. For all the pundits who see the economy improving over the next year, we invite you to explain to us how this debt crisis will resolve itself without significant turmoil.”

Moral of the story (if you haven’t learned it already): Even central bankers can’t fake reality for ever.

UPDATE 3: As Mr Crampton says, Larry White’s free banking regime has much to recommend it.