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devil duck

armchair economics

So Krugman points to this commentary in the NY Times, calling on the Federal Reserve to "show some spine and raise interest rates."
The case for raising rates is straightforward: Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth....
The only way to return the assessment of risk to something resembling normalcy is to stop the manipulation. That requires nothing less than serious intestinal fortitude from the Fed and a willingness to raise interest rates in the face of determined opposition from Wall Street.

Wait, what? When the Fed sets interest rates to 0.25%, that's "manipulation by a market behemoth", but when the Fed sets interest rates to 1% or 2%, that's "stopping the manipulation" and allowing "supply and demand"? Seems to me the only way to "stop the manipulation" would be for the Fed to not set interest rates at all -- to be just another big bank with no economic goals but maximizing its own profit. Which Rand Paul might appreciate, but most people would consider a rather extreme shift from the past several decades.

In fact, a number of the calls for an immediate interest-rate hike (over the past five years) have been based on the notion that current Fed interest rates are "unnatural" and "artificially low", which as far as I can tell means "lower than they've been for most of the past fifty years" rather than having any objective basis.

I'm not sure how that's possible. The Fed is basically a really big lender-to-the-trade: if it sets interest rates "too low", i.e. lower than "the market" would on its own, banks will borrow vast amounts of money from the Fed, turn around and lend it out at higher rates to those poor suckers who can't get to the Fed's discount window, and make vast amounts of money on the difference. This would continue until either the demand for credit was met and "market" rates dropped to match the Fed's rate, or the Fed raised its rates to match the "market" rate. In the process, an enormous amount of money would flow into the functioning economy and be chasing either (a) too few goods and services, aka inflation, or (b) rapidly growing goods and services, aka rapid GDP growth. The fact that neither the arbitrage, the inflation, nor the rapid GDP growth seems to have happened on a large scale despite six years of "artificially low" interest rates seems to be pretty good evidence that they're not "artificially low" after all: those banks that have borrowed money from the Fed at 0.25% haven't found an abundance of high-yield places to lend that money, so it's just sitting in their vaults.
The right answer is self-evident: End the easy-money addiction, raise rates in September and begin the healing.

The words "begin the healing" suggest the reasoning he's using. As long as interest rates are "artificially low", there won't be the round of bankruptcies and extreme economic hardship necessary to pay off the karmic balance of the pre-2008 economic party, and without paying off that karmic balance, things will never get back to normal. To quote Ron Paul in 2009:
We need a correction. Correction should be a good word. When the government screws things up and makes things, you know, so much out of whack, we need a correction and a correction is a healthy thing and everything we do in Washington, everything the Central Bank does is they work real hard to prevent the correction. That’s why it’s prolonged.
In this view, the best solution to an economic slump is to "rip the bandage off" -- create some intense, immediate pain, with the understanding that things will then get better. When your people are out of work, you should lay off government workers; when your people have no money to spend, you should cut unemployment benefits and raise taxes; when the private sector isn't buying enough to keep the economy moving, the government should stop buying things too.

The problem is that there's no evidence that "ripping the bandage off" actually helps in economics (except in the "feels so good when you stop" sense). The countries that took the strongest doses of austerity medicine (Spain, Portugal, Ireland, Italy, and above all Greece) have had the weakest economic recoveries, while the places that enacted only moderate austerity (the U.S.) have had the strongest (albeit still slow by comparison with previous slumps that were not medicated with austerity).

This "rip the bandage off" reasoning seems to be based on two flawed assumptions. One is the notion of "karma", of macro-economics as a morality play in which irresponsible partying must be paid off with suffering (oddly enough, never by the same people who most enjoyed the irresponsible partying) before the party can resume. The other assumption is that an economic system has one and only one natural, stable equilibrium point, to which it will return automatically whenever the hand of government is removed. As long as government keeps trying to stimulate the economy, we must be operating above the equilibrium and would be better off letting the economy fall to where it "wants" to be. But what if the same fundamental economy could have several different possible stable equilibria? You could have lots of people employed and spending money and supporting other people's jobs, or you could have very few people employed and spending money and supporting other people's jobs, and both of those would be stable situations. Which means it's plausibly a legitimate government goal to pick a happier equilibrium over an unhappier one.

But that would mean government has a legitimate role in managing the economy, and "keeping big business owners happy" isn't the only road to prosperity. Unthinkable.

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