Press the brakes to avoid an accident – Twin Cities

The Federal Reserve continues to make news. The immediate speech on the Fed's policy of gradually raising short-term interest rates and the harsh criticism of President Donald Trump has quieted down. But the problems the Fed will face will continue. And who wins in the next election makes little difference.

The level of attention given to the Fed is a symptom of disease in our economy. Every economy needs a central bank. A successful man succeeds in maintaining a reserve of money commensurate with the needs of society as a "medium of exchange" and "store of value", while maintaining this money as a "standard of value".

In other words, make sure money is in circulation so that people can buy and sell things, save value over long or short periods, and keep the overall price level stable, without inflation. nor deflation.

Beyond that, what a central bank can accomplish is limited. It can not solve the myriad economic problems of hard-to-employ people or the inequitable and inefficient distribution of income. It can not grow an economy faster once its structural growth capacity is engaged. And it can not and should not try to make "real" value, ie the value of inflation-adjusted assets such as equities, bonds, houses or farmland, fruitful.

History not only shows that such lawsuits are futile, but it actually hurts a society in the long run.

Now let's take a look at the Fed's announced program of gradual rate hikes, a program supported by President Jerome Powell and several members of his steering committee charged with making political decisions against Trump's critics.

Trump's position is purely political. Other reviews are more nuanced.

Some say that higher rates would prematurely end further increases in employment, leaving some people still in limbo. Or, higher rates would prematurely thwart the strong growth in economic output, just as it actually grew after the Great Recession.

This argument is advanced by very well placed people. Neel Kashkari, the young and energetic chairman of the Minneapolis Fed, presented the case in an editorial published Oct. 25 in the Wall Street Journal. After being a voting member of the FOMC's decision-making committee in 2017, he will have formal word in politics until 2020. But he can express his opinion. When he says, "Pressing the brakes prematurely could dampen wage growth and prevent many Americans from participating in the economic recovery," that carries some weight.

But I think he's wrong overall. I agree with him that he is right in saying that we are not facing an imminent threat of a sharp rise in the prices of consumer goods or even the larger list of all output as measured by GDP. But there are other considerations, other possible disadvantages, beyond that. And I think it overestimates the effectiveness of increasing break rates as a tool to increase employment and wages.

There is a great irony in his position. For 35 years, the research department of the Minneapolis Fed, as well as the economics departments of Minnesota and Chicago Universities, have stood out in defending the position that there is no compromise between inflation and unemployment except in the very short term. Limiting the money supply, interest rates, taxes, and expenditures to micromanaging production and employment was seen as not only futile, but inevitably detrimental.

At the end of 2009, when Narayana Kocherlakota, Kashkari's predecessor, switched from the head of the U Department of Economic Affairs to the chairman of the Minneapolis Fed, he was in that camp. Kocherlakota's "Damascus Road" has become the strongest advocate for the use of extremely low interest rates over a prolonged period to promote growth and employment, which has provoked a deep insurgency on the part of former colleagues and his own research staff. Kashkari is now defending the same policy.

It's ironic for me too. When the anti-Keynesian anti-intervention economics school and rational expectations dominated the Fed and the U of M, I was skeptical. It was too absolutist, too based on very questionable assumptions about human behavior, too close to a religious cult in some cases. But I am only a humble applied economist. This group has won the day in the overall economy. In 2000, virtually no doctoral degree in macroeconomic theory advocated the Keynesian use of cash and tax as well as brake pedals.

Without fully swallowing their theoretical model, rational espionists certainly did well to explain how militant politics had played out in the real world in the 1960s to 1980s. Trying to micromanage economies with fiscal and monetary policies can have serious unintended effects. It is not necessary to be a fervent believer to see it.

Those like Kashkari, who advocate a pause in a process of slow rate increases to bring more people into the labor market, raise wages, or expand an already over-stretched economy, are implicitly going beyond what the doctrine already advocated. Keynesian countercyclical. never had in mind.

The idea was that, if there was a recession and that many resources, including the workforce, were idling in an economy, the government could and should bring it back to a greater productivity.

If an economy were booming, with production and employment levels above what can be sustained over a long period of time, the government could slow things down.

But no reputable economist has ever argued that such short-term measures could increase the long-term growth rate of an economy. It depends on more fundamental structural factors. No one ever argued that interest rate and federal revenue expansion measures were an effective tool for integrating hard-to-employ people into the job market, nor for increasing corrected wages. of inflation. These are laudable goals, but removing interest rates is not a good way to achieve them.

It can not be examined in a vacuum either. What can be a viable compromise in more normal times may not be wise in unusual circumstances. We have been recovering for a long time from the worst economic downturn in 70 years and getting closer to the brink of a financial meltdown since 1929-1933. We are not in the mid-1960s or the 1990s.

The elephant in the room, which few people will speak directly, is the unsustainable boom of the stock market and other asset markets, coupled with a high and rising debt level for households, businesses and public administrations. This stems in part from the unprecedented easy money of the last decade.

Economists simply do not want to deal with this because it does not fit perfectly with anyone's models. Ask if the Fed's inflation model should take into account the price increases of financial and real assets rather than consumer prices. You will probably be told that a central bank has no way of determining the "right" price level of shares or land and therefore should ignore it. This is a dangerous loophole that undermines the credibility of the contemporary economy.

In 1821, David Ricardo, father of the modern economy, explained that the market price of any productive asset, such as farmland, depended on the annual income produced and the interest rate. Lower the interest rate and the price of land goes up. Extend that to stocks and other assets and add the expected income on a longer horizon rather than now, and you have a contemporary understanding.

There is no doubt that a decade of extremely low interest rates is a major factor in stock prices, housing, commercial real estate and farmland. Powell and some of his colleagues understand that trying to maintain the unsustainable ends up being subject to more stringent subsequent adjustments than if incremental adjustments are allowed. Hence the fact of pressing the brakes to avoid a sudden inevitable stop. Or worse, an accident.

Similarly, cheap money has encouraged countries, including many poor, businesses, households and governments to incur more debt than they can repay. Again, gradual adjustments are preferable to sudden and violent adjustments.

The downside of cheap money that encourages borrowing is that it punishes savers. These include more than 75 million baby boomers drawing in their 401 (k) s and other resources that have been hit by low long-term rates. When the stock market was in free fall in 2009, many were worried about the loss of capital. But the long-term success they have experienced is in the permanent income of their capital.

Our economy is much less healthy than many people want to admit. It is better for housing prices to rise and house prices to fall and fall, for borrowers to reduce their debt in an orderly fashion, and for their savings to increase, rather than allowing the good times to be in the wall.