I have a theory that at least some people at the Fed are supporting interest rate increases not because they are worried about incipient inflation that must be nipped in the bud in advance under a regime of inflation targeting, but because they are looking over the horizon and worrying about a possible recession in the not-too-distant future, and they want to be able to have interest rates high enough that they can then engage in lowering them as a stimulative policy tool under the circumstances. If they are too low, then extraordinary measures will need to be used, and some of those measures may not be available in the future.
This theory is based on nothing solid at all, nothing. I think that those who may be thinking this (and my likely candidate(s) would be people at the very top) are constrained in speaking openly due both to the current institutional arrangement of consensus decisionmaking within an established inflation targeting system with a 2% inflation target, not to mention pressure not to talk about possible future dangers. The current line is that the economy is doing well, and certainly it is on the standard measures of unemployment and inflation, even if the former could be better and wages could be rising more rapidly. Indeed, it is this good performance that is supposedly underlying the moves to raise interest rates and possibly "normalize" the balance sheet (which I doubt there will be too much action on). But my theory is that for some of them it is a matter of trying to "normalize" on interest rates as well while the possibility of normalizing is possible, while the economy is doing fairly well and one can raise them without obviously slowing things down noticeably, so that indeed there will be the ability to lower them again in the future when necessary.
He did not put this theory forward, but it was reading the recent column by Larry Summers that appeared in the Washington Post on Monday was been linked to by Mark Thoma today (unable to make that link, sorry) and also can be gotten to at larrysummers.com/2017/08/14/why-the-federal-reserves-job-will-get-harder. He is focused on the upcoming ending of the term of his rival as Chair of the Fed, Janet Yellen, and is worried about who Trump will pick and what will happen. While stating that he would have "preferred a slower pace of interest rate adjustment," he bottom lines that "Overall it has done well in recent years" (even though he did not get picked to be Chair).
While he thinks the economy is currently doing pretty well, looking forward he worries tha it is "brittle" with numerous dangers, and opines that there is a two thirds chance of a recession during the next Fed Chair's term. He then notes how the still low interest rates will make it hard to use the interest rate tool to stimulate the economy, making it difficult for the Fed to do much. He does not make the leap I did to the possibility that this fact may be on the minds of at least some people at the Fed, although they really cannot openly say it.
I agree with his concerns about what is coming due to the political situation, with "major risk now of presidential interference" in the Fed, and he makes disparaging remarks about the president quite reasonably so. He also notes that the "temper of the times has turned against technical expertise in favor of populist passion." There is reason to be concerned about what he will do.
But in the meantime some people at the Fed may be doing their best to make it possible for the Fed to do something in the future when the need will surely arise.
Barkley Rosser
5 comments:
The money stock can never be managed by any attempt to control the cost of credit. Interest is the price of loan-funds. The price of money is the reciprocal of the price level.
It was not so very long ago that most pundits were calling for the FED to rapidly increase the FED funds rate out of concern for the twin evils of: 1) runaway inflation, and 2) Oldsters who were not earning enough interest on their savings accounts! It turns out the latter was just a marketing ploy as the vast majority of Americans have little or no savings and, surprise, surprise, the much feared inflation never materialized. Fast forward a couple of years, and we are now objecting to the FED raising interest rates for fear of....... I guess the answer would be, an end to the current economic expansion. As for the comments about Larry Summers, they seem a little mean. Mr. Summers is hardly the only person who would like to serve as Fed chair, although God only knows why anyone would want the abuse and second guessing that goes along with the job. Mr. Summers has his point of view and time will tell whether or not he was right.
Getting interest rates back up to a point where lowering them again would be stimulative---by Occam's Razor, I think you nailed it!
An other or simultanious possibility, is that real fed funds interest, discounted for inflation, have been negative.
RI=(1+i)/(1+inflation rate)-1
Where, terms are in fraction, not %. Ie 10% would be 0.10.
Where RI is "real interest rate" and i is interest rate.
Approximated by RI~=i-inflation rate, for rates under 15%.
I wish they would provide some rigorous proof that lowering interest rates actually stimulates either investment or consumption. When I took Econ 101, in 1959, my teacher said they learned in the 1930s that "pushing on a string" was not helpful in combating the Depression. The economists who maintain the idea seem to be assuming it, just like a can opener.
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