By Philip Pilkington, a journalist and writer living in Dublin, Ireland
JK Galbraith, remarkably, regards the Federal Reserve as a largely powerless institution; he dismisses the idea that the Fed can end a recession by cutting interest rates as a “quasi-religious conviction” that “triumphs over conflicting experience.”… Because Galbraith believes monetary policy cannot increase demand, however, he has a sort of Depression-era vision of an economy in which anything that increases spending is good… And so Galbraith is oblivious to the most serious problem facing modern liberalism: reconciling social justice with full employment.
As the above, rather embarrassing quote from Paul Krugman’s review of JK Galbraith’s classic book The Affluent Society shows, neoclassical economists and neoclassically-trained central bankers have long been enamoured with monetary policy – and are generally angered when it subject to questioning. Why? Well, there are a variety of reasons, some of these are ideological (monetary policy doesn’t stink too badly of nasty government interference with the Holy Market), some of these are purely functional (the central bank has independent control over rates) and some simply have to do with making economists’ silly toy-models work (monetary policy gives neoclassicals a feeling of power over the economy they would otherwise lack).
Anyway, in the present crisis – just as in the great depression – monetary policy has proved completely ineffective. This has caused some – myself included – to question the real efficacy of monetary policy altogether, but it has others continuing the search for that silver bullet.
While Bernanke et al have been bungling through with hapless and ineffective quantitative easing policies and ‘operation twists’, commentators like Krugman – who cut his teeth getting Japan wrong for years – have come out in support of negative interest rate policies, which essentially means trying to provoke inflation that will cause real interest rates to be effectively negative. These are two sides of the same bad economic model, I’m afraid. They are both based on the same crappy engineering-diagram-cum-economic-model and they both steadfastly refuse to recognise the key lesson Keynes tried to teach us about capitalist economies: namely, that the whole thing is subject to an overarching indeterminacy that cannot be accounted for in a childish toy-model based on equilibrium analysis.
In fact, interest rate policy in the present environment is not simply worthless – it actually worsens the state of the economy to some degree. Why? Because of interest income channels. When the central bank lowers interest rates they assume that people will borrow more. And when Krugman says that we should have inflation outpace the interest rate, he is thinking along the same lines. What these folks never consider is the fact that low interest rates actually act as a net drain on new financial assets entering the economy.
If I’m a saver – and there are a LOT of savers out there these days – and the central bank lowers the interest rate or targets a negative real interest rate, I lose interest on my savings. This ‘interest income’ would have added to aggregate demand – that is, total spending power – as it would mean new net financial assets flowing into my bank account and encouraging me to consume more. Instead, my savings sit around idly earning nothing and so I have even less of an incentive to purchase goods and services.
The MMTers – especially Warren Mosler – have been pointing this out for years, but to no avail. But now the idea is starting to get play among the VSPs (Very Serious Persons). While most analysts focused on yawn-inducing speculation about the possibility of the Fed running a pointless QE3 program, some more nuanced analysts noticed something of actual interest in the recently leaked Fed minutes. Per the minutes:
It was noted that very low interest rates were negatively affecting pension funds and the profitability of the life insurance industry.
That is not much, of course, but at least it is something. It is, at the very least, a jumping-off point for those of us who are sceptical about the efficacy of monetary policy to get a foot in the door.
This is not so much a policy issue as it is a theoretical issue. Monetary policy acts for many analysts as a soporific, putting them to sleep when they should be focusing on real issues. It feeds nicely into their equilibrium models and allows them to sleep a little better at night. Even during the crisis their silly toy-models can yield them hours of fun as they tinker with them to produce higher inflation and lower interest rates. Meanwhile, Rome burns – and Keynes rolls in his grave.
Discussions like this can refocus policymakers’ interest in fiscal policy by showing that monetary policy is a bunch of watered-down hooey that is fickle and unpredictable in its effects. In that, we can try to exorcise the neoclassical demon as best we can and bring government policy back to where it was in the three decades after WWII. Here’s hoping.