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Paul Krugman has an excellent post demolishing the following claim by William Cohan, in the NYT:

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. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying.

BTW, Krugman’s post is the one to read (not mine) if you only look at one post on this topic. He carefully walks through an explanation of what’s wrong with this paragraph, in a way that would be recognizable to any competent monetary economist. But in some ways it’s even worse than Krugman assumes. Here’s Krugman:

The Fed sets interest rates, whether it wants to or not “” even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice.

That’s also my view, but I suppose one could argue that from a different perspective if you set the money supply you are letting markets determine interest rates, whereas if you actually target interest rates, then you are “interfering” in the market. Not exactly my view, but let’s go with it. Let’s put the best spin on Mr. Cohan’s essay.

Now here’s the big irony. For the past seven years the Fed hasn’t been targeting interest rates, they’ve been using base control to influence the economy, increasing the monetary base through QE programs. They switched from interest rate control before 2008 to monetary base control after. And now Cohan is calling for the Fed to raise interest rates. That means he wants the Fed to go back to manipulating interest rates.

So the great irony here is that in the paragraph I quoted from above Cohan says:

Like any commodity, the price of borrowing money “” interest rates “” should be determined by supply and demand, not by manipulation by a market behemoth.

And yet in the essay he’s actually calling for the exact opposite; he wants the market behemoth (the Fed) to start manipulating interest rates, something it hasn’t been doing for the past 7 years.

Unlike quantum mechanics, monetary economics doesn’t seem too hard. As a result the media produces a non-stop stream of stories on monetary policy that are utter nonsense. And by “utter nonsense” I don’t mean stories that disagree with my particular market monetarist views (Cohan might be correct that the Fed should raise rates), but rather stories that are simply incoherent, that are completely detached from the field of monetary economics.

We don’t hire plumbers to teach quantum mechanics at MIT. We don’t put plumbers on the Supreme Court. But we do put Hawaiian community bankers on the Board of Governors. It’s not just that our media and Congress and President don’t understand monetary economics, they don’t understand quantum mechanics either. The real problem is that they don’t even understand that they don’t understand it. So they have unqualified people write op eds, and sit on the Board of Governors. People ask me what Trump or Sanders think about monetary policy. They don’t even know what it is! What they think doesn’t matter, even if they were to get elected. Just as it doesn’t matter what their view is on the best trajectory for NASA’s next Saturn bypass.

BWT, I have no problem with Hawaiian community bankers having important policymaker roles at the Fed, but put them on the committee for banking regulation, not monetary policy.

The title of the NYT piece said the Fed needed to “Show Some Spine”. Over at the Financial Times they want the Fed to “Show Steel.” (I guess that makes Paul and me wimps.) Here’s the argument at the FT:

Yet monetary policy cannot confine itself to reacting to the latest inflation data if it is to promote the wider goals of financial stability and sustainable economic growth. An over-reliance on extremely accommodative monetary policy may be one of the reasons why the world has not escaped from the clutches of a financial crisis that began more than eight years ago.

I suppose that’s why the eurozone economy took off after 2011, while the US failed to grow. The ECB avoided our foolish QE policies, and “showed steel” by raising interest rates twice in the spring of 2011. If only we had done the same.

Of course I’m being sarcastic, but that points to another problem with the Cohan piece. Rates are not low because of QE (as Cohan implied), indeed Europe didn’t do QE during 2009-13, and that’s why its rates are now lower than in the US, and will probably remain lower.

If this stuff is published in the NYT and FT, just imagine what money analysis is like in the average media outlet, say USA Today or Fox News.

HT: Tom Brown, Stephen Kirchner

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This entry was posted on August 30th, 2015 and is filed under Monetary Theory, Praising Krugman. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



