Tim Taylor writes about low interest rates. As he notes, many economists see low rates as a natural (in both the colloquial and Wicksellian sense) response to a weak economy; but he respectfully cites the Bank for International Settlements, which argues that low rates are a source of terrible economic distortions. But it seems to me that there’s some context missing.

Taylor writes,

Notice that none of the BIS concerns are about the risk of a rise in inflation–which it does not think of as a substantial risk.

Ah, but it used to think otherwise. It has been calling for higher interest rates for around 5 years, and at first it was indeed warning about inflation. In its 2011 report, in fact, it declared that

Highly accommodative monetary policies are fast becoming a threat to price stability.

That was dead wrong, and the ECB — which believed in the inflation threat and raised rates — clearly made a big mistake. So you might have expected the BIS to ask why it was so wrong, and reconsider its policy recommendations. Instead, however, it continued to demand the same policies, while inventing new justifications.

And I mean inventing. As I’ve written many times, the remarkable thing about policy since 2010 is that outsiders, particularly bearded academics, have based their criticisms of policy on mainstream, textbook economics; whereas serious-sounding bankers in suits have been creating whole new economic doctrines on the fly to justify what they claim are sound policies.

In this case, the BIS not only claims that low interest rates cause financial instability, but goes on to expound a sort of widow’s cruse theory of interest rates, in which low rates today lead to even lower rates tomorrow, because they produce bubbles that weaken the economy further when they burst. That’s pretty wild stuff; you wouldn’t want to take it seriously without a lot of evidence, which the BIS does not provide.

Or put it this way: if, say, Jeremy Corbyn or Bernie Sanders were to invent whole new, dubious economic theories to justify the policies they clearly want for other reasons, everyone would be coming down on them hard for being flaky and irresponsible. Yet when the BIS — which was, once again, dead wrong on inflation — does the same thing, it’s taken very seriously.

One more thing: I was especially annoyed at the BIS’s claim that we now know that pre-crisis estimates of potential output were greatly overstated; they mention the US in the mid-200s as an example. But we know no such thing. Some methods widely used to estimate potential output in effect assume that the economy has a strong tendency to return to full employment, so if we see a prolonged slump those methods rewrite history, concluding that the economy must have been badly overheated before the slump. But why should we believe that conclusion? The US wasn’t experiencing accelerating inflation at an unemployment rate around 5 percent in the mid-2000s; it’s not seeing accelerating inflation now, with unemployment back to the same vicinity. Doesn’t this mean that it wasn’t overheated either time?

Again, if someone from the center-left were to produce an economic analysis this tendentious, this much at odds with decades of mainstream economics, it would be met with incredulity. It’s awesome to see the ultra-respectable BIS go down this path, and be taken seriously along the way.