End the Insanity

Printing money

Again, a Zero Interest Rate Policy (ZIRP) is a signal of a very sick economy where the time value of money is zero and savings income is driven to zero. It should be temporary. With their policy choices, the central banks are essentially telling us this is a semi-permanent state of affairs. In other words, they have no other tools to jump-start the economy and create jobs.

No kidding. Can’t make it better, but they sure can make it worse.

Economist Ronald McKinnon quoted from the WSJ:

If presidential nominee Janet Yellen succeeds Ben Bernanke as Federal Reserve chairman when his term ends Jan. 31 (and I see no reason she won’t), she will inherit a vexing dilemma: To taper or not to taper.

The major objection to this kind of policy change is that the “recovery” from the subprime mortgage crisis and economic slump of 2008 is so weak that the economy can’t withstand any increase in interest rates. This general concern with economic weakness is what pushed the Federal Reserve into its near-zero interest-rate trap to begin with—followed by the Bank of England, the European Central Bank and the Bank of Japan. All four central banks have fallen into similar traps and their economies remain sluggish.

What is at fault here is conventional macroeconomic theory. First, although reducing high interest rates to more moderate levels is stimulating for aggregate demand, going from moderate rates to near-zero rates has proved far less effective. Second, fine-tuning monetary policy to target a nonmonetary variable, such as the level of unemployment, has become an ill-advised fetish. What Milton Friedman taught us in his famous 1967 address to the American Economic Association, “The Role of Monetary Policy,” is that central banks cannot (and should not) persistently target a nonmonetary objective—such as the level of unemployment, which is determined by too many other factors.

The most straightforward approach now is for the leading central banks—the Federal Reserve (perhaps with Ms. Yellen at the helm), the Bank of England, the Bank of Japan and the European Central Bank—to admit that they were wrong in driving interest rates too low in the pursuit of a nonmonetary objective such as the unemployment level.

They could then begin slowly increasing short-term interest rates in a coordinated way to some common, modest target level, such as the 2% suggested here. Coordination is crucial to minimize disruptions in exchange rates. Then our economic gang of four should, in a measured and transparent manner, phase out quantitative easing so that long-term interest rates once again can be determined by markets.


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