Tuesday 9 June 2015

Are interest rates too high or too low? [updated]

Are interest rates too high or too low?

A comment by Roger Garrison from 2002, when the world was trying to recover from the ‘original’ DotCom bust, is still relevant today … …

‘Keynesian stabilisation policy’ should be seen for the oxymoron that it is.  Keynesian policies don’t ‘stabilise’ the economy; they Keynesianise the economy.  That is, a policy-driven economy mimics the unstable behaviour that Keynes thought to be characteristic of a market economy.
    So now the central bank has ratcheted the federal-funds rate down to 1.75%, with medium- and longer-term rates coming down to a lesser extent.  Having failed to stimulate much investment, the cheap credit has stimulated consumer spending instead.  And neither [head of the central bank] nor anyone else is sure what to do next.
    Is 1.75% to high or too low?
    The answer is: both.
    The 1.75% is too high in light of the volatile and faltering asset prices and the paucity of job-creating investment.  But it’s too low in light of plausible values for the natural rate of interest, which alone can be associated with sustainable economic growth.  Furthermore, the too-high/too-low diagnosis gives rise to the very uncertainties that dampen investor optimism and hence whet political appetites for Keynesian stabilisation policies.

And so, rinse and repeat, And then repeat again. Names and details changed, but the song remains the same.

Perhaps the only major differences this time the song is sung is that instead of stimulating consumer spending, cheap credit has instead stimulated an accelerating stock-market “rally,” and the federal-funds rate is heading even lower.

But neither Janet Yellen nor anyone else is sure what to do next.

UPDATE:

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