Still convalescing from This Week; but it helped focus my thoughts a bit more on the jihad against low interest rates.

What I realized is that Stockman, and many others, represent the latest incarnation of sado-monetarism, the urge to raise rates even in a deeply depressed economy. It’s a long lineage, going back at least to Schumpeter’s warning that easy money would leave “part of the work of depressions undone” and Hayek’s inveighing against the “creation of artificial demand”. Nothing must be done to alleviate the pain!

I have to admit that the resurgence of sado-monetarism has come as a surprise. In the early stages, some readers may recall, there were many people — e.g. my colleague David Brooks — arguing that we should use monetary rather than fiscal policy to respond to the crisis. The hard task of persuasion therefore seemed to be one of explaining the zero lower bound and why it matters, the great difficulty of getting monetary traction and hence the need for fiscal action.

But now that the deficit scolds have killed fiscal policy, monetary policy is also under attack, and with even more vehemence. Yet there’s something very odd about that attack.

The modern sado-monetarist view is, after all, very much centered on the presumption that markets, left to their own devices, will get it right, and that it’s only the distortions introduced by money-printing central banks that cause bubbles and crises — which is why the Fed must stop its easing right away.

But here’s the problem: for loose monetary policy to have the dire effects the sadomonetarists claim, markets must massively get it wrong, and hugely overreact to low interest rates.

Suppose, to take the obvious example, that your claim is that loose policy by the Fed caused the housing bubble, and hence all our current woe. Well, it’s true that borrowing costs were relatively low during the bubble years. Here are mortgage rates:

Photo

So mortgage rates fell by about 20 percent from late-90s levels. If housing prices were the simple inverse of bond prices, this could explain something like a 25 percent rise. Realistically, you can adjust this either up or down; focusing on real rates would push the number up, realizing that there are other costs to buying a house would push it down. But one thing seems clear: on no rational calculation can the fairly modest interest rate decline shown above justify this:

Photo

Now, you could try to explain the doubling or more of housing prices in key markets by arguing that low interest rates were what set in motion a process of irrational exuberance, in which lenders and borrowers both got carried away; I would agree with Ben Bernanke that most of the evidence suggests otherwise, but your mileage may vary. The point, however, is that even if you want to make the Fed the villain here, you can only do that by assuming that markets are highly irrational and unstable. If they can overreact so drastically to loose money, why should you believe that they get it right in response to other shocks?

So sadomonetarism is intellectually inconsistent. It wants to blame central banks for all the instability in the economy, it preaches a doctrine of non-intervention, but it can only make the case by insisting that financial markets are irrational and unstable to begin with, in which case it’s hard to see why laissez-faire makes sense under any conditions.

And no, I don’t think the sadomonetarists have thought this through. Their position isn’t intellectual, it’s visceral: easy money=sin, and must not be condoned. And while everyone is entitled to his own viscera, this is no way to make economic policy.