The New York Times believes that interest rates need to be higher, unemployment needs to be higher, and economic growth needs to be slower. And it's not because it fears inflation.
This is a truly weird article. The weirdest thing is the claim that low interest rates are "shock therapy": shock therapy is high interest rates. The second weirdest thing is the claim that buyers of stock in 1999 and 2000 "were not warned enough" about the "speculative financial market bubble" and that interest rates should have been higher (and unemployment higher) in the late 1990s to save investors from themselves. Perhaps they mean that the New York Times should have published more of the warnings about financial market speculation that were being issued by people talking about "irrational exuberance," as Alan Greenspan called it?
Posted by DeLong at March 22, 2004 05:28 PM | TrackBack | | Other weblogs commenting on this posthe Federal Reserve Board announced yesterday that it would keep its overnight interest rate where it has been for nine months--at 1 percent, its lowest level since 1958. Factor in inflation, and Alan Greenspan is essentially lending money at a loss. This cannot go on indefinitely, and it should not go on much longer. In this election year, Mr. Greenspan and the other Fed officials are under tremendous pressure to stay put on rates in the absence of a tightening labor market or other signs of inflation, but such a stance would be a mistake. There are other costs associated with exceptionally cheap money that the Fed must recognize, and address by gradually raising rates.
There is no question that the Fed's loose monetary policy helped jolt the economy back to life last year. It increased corporate profits and prompted consumers to refinance their mortgages and to spend their way into plenty of other debt. That mission accomplished, the argument for keeping rates at crisis-driven shock-therapy lows is that businesses are still not hiring, and that there is no sign of inflation on the horizon. Those are the classic cues the Fed awaits before raising rates.
The sharp spike in the productivity growth rate in recent years explains why mass hirings and signs of inflation are scarce even with a rebounding economy. But the Fed cannot afford complacency.
Mr. Greenspan should heed the lessons of the stock market bubble of the late 1990's. In the new economy, remember, we were assured that the old speed limits needn't apply. What investors were not warned about enough was the extent to which the virtuous cycle of cheap money, low inflation and strong growth was feeding a speculative financial market bubble, which eventually popped at huge cost to those investors.
Now there are other hints that too much of a good thing can be dangerous. In some parts of the nation, housing values suggest that another bubble is forming. Many homeowners, and consumers in general, are borrowing recklessly, betting that rising housing prices and easy credit are here to stay. With 30-year loans available at 5.5 percent, mortgage debt soared to $6.8 trillion last year, from $4.9 trillion in 2000. The nation may be in for a rude shock when the real estate market levels off, and when millions discover that the adjustable rates of their mortgages and other loans can be adjusted upward.
The Fed should gradually wean the country off such extraordinarily easy money before it is forced to do so abruptly, and painfully. It cannot wait until after the election, nor until it sees inflation pick up. Rates are so low that the Fed has plenty of room to move before being accused of adopting a restrictive monetary policy. It needs to get started.
"The Fed should gradually wean the country off such extraordinarily easy money before it is forced to do so abruptly, and painfully"
What reasons if any are there to support the idea that short term rates shouldn't be moved abruptly when required to keep the economy close to the level where inflation is stable?
If anything, I would think that the most important thing would be the stability of inflation and long rates. Trying to act like short term rates are anything other than short term seems to defeat the purpose of their existence.
Posted by: snsterling on March 22, 2004 06:21 PMThis is where simple folks like myself always wind up baffled by what seems like a deliberate asymetry in how economists think. Why is it that high interest rates are shock therapy but low interest rates aren't? Why is it that economists recommend cutting interest rates if the stock market tanks, but don't recommend raising interest rates if the stock market soars? It all seems rather odd and lopsided to me.
Posted by: Non-economist on March 22, 2004 06:27 PMBrad, you've posted quite a few links to articles discussing the possibility of a housing bubble, yet you've never said yourself whether you believe there is one or whether such bubbles are detectable or preventable. Why are you posting all of these without comment on this?
Posted by: fling93 on March 22, 2004 06:40 PMWhen it comes to monetary policy, I'm sort of like the "concerned mother" on VCPR in Grand Theft Auto: Vice City -- self-described as "moronic and opinionated."
Nonetheless, I am starting to worry that there might be some moral hazard in having the Fed giving away money (or lending without appreciable interest).
Flame away...
Posted by: Jim D on March 22, 2004 09:23 PMIf anything continues long enough someone will try to stop it. Anti-development movement is a great example.
Posted by: beanbaby on March 22, 2004 10:05 PMCheap money means expensive oil and expensive vacations, for two.
Posted by: Andrew Boucher on March 23, 2004 02:36 AMCheap money means consumers taking on debt loads that will rapidly become unsustainable when, inevitably, interest rates rise. Especially true for homeowners who have been bamboozled by Greenspan's irresponsible suggestion that they would be better off with adjustable rate mortgages.
Brad is focused on the macro consequences of Fed policy, and he's right that rates have to remain low while job growth is so weak - a sudden increase would worsen job market conditions and jeopardize the recovery, such as it is. In any case, the REAL interest rate is not that low - somewhere between 0.5% and 1.0%, depending on how you measure it.
The problem is that, in the usual formulation, a low interest rate is supposed to act mainly on business decision-making.
In this episode, however, it seems to me that the most important effect has been on private households - steadily falling rates have allowed homeowners to become serial mortgage refinancers. That would be an unmixed blessing if it involved nothing more than improving household cashflow, but of course millions of people have been simultaneously using the increased equity in their homes to add to their mortgage debt.
So instead of the usual workout of over-extended household debt that you would expect to see in a post-bubble environment, families and individuals have become substantially more indebted. That has kept the economy afloat, a good thing, but it also leaves these people still more vulnerable to a change in economic conditions. It seems to me that talk of a housing bubble is a red herring - the real problem is the level of household debt.
The dilemma right now is that it would be insane to raise rates - but the longer we leave them at this level, the greater will be the credit problems once they are raised. Maybe we should anticipate the rise of a pro-inflation borrowers lobby.
Posted by: Dave L on March 23, 2004 03:14 AMThe Fed, unfortunately, seems to have worked itself into a corner. Despite continued low interest rates, the job market remains stagnant at best. Low short-term interest is now a blunted instrument on this edge.
Yet, there are indeed danger signs that easy money is producing a credit-based housing bubble. Yet, the tool the Fed could use to slow the growth of this bubble--raising short-term rates--proves to be extremely sharp on this edge. A rise in rates would have a rather severe impact on consumer spending as debt service would instantly begin biting huge chunks out of consumer's descretionary spending. With that, the economy would probably lapse into fairly severe recession.
Posted by: Derelict on March 23, 2004 06:31 AMI think it weird to describe the article as weird. It could have been written by Milton Friedman; i.e. "cheap money" = dear goods and services (not low interest rates).
Posted by: Patrick R. Sullivan on March 23, 2004 08:55 AMDave L. (March 23, 2004 03:14 AM) says:
"Brad is ... right that rates have to remain low while job growth is so weak - a sudden increase would worsen job market conditions and jeopardize the recovery, such as it is. In any case, the REAL interest rate is not that low - somewhere between 0.5% and 1.0%, depending on how you measure it."
Do we really have a recovery, or just a mirage? If we have a mirage, then it seems to me that we are pumping easy money into a bubble machine, and that will spell disaster as the folks at The Economist (and elsewhere) point out.
And: "In this episode ... the most important effect has been on private households - steadily falling rates have allowed homeowners to become serial mortgage refinancers ... using the increased equity in their homes to add to their mortgage debt."
"So instead of the usual workout of over-extended household debt that you would expect to see in a post-bubble environment, families and individuals have become substantially more indebted. That has kept the economy afloat, a good thing, but it also leaves these people still more vulnerable to a change in economic conditions. It seems to me that talk of a housing bubble is a red herring - the real problem is the level of household debt."
Again, keeping the economy afloat is only a good thing if there there is some semblance of sustainability to this so-called "recovery." Aren't the "housing bubble" and "the level of household debt" pretty much flip sides of the same coin?
And: "The dilemma right now is that it would be insane to raise rates - but the longer we leave them at this level, the greater will be the credit problems once they are raised. Maybe we should anticipate the rise of a pro-inflation borrowers lobby."
Why would it be "insane" to raise rates if all we are doing by pumping money into the system is blowing bubbles?
Brad: Where are your promised models/stories of what to do in the wake of The Bubble?
For more on why we might be seeing a mirage, and coincidentally what is wrong with many prevailing theories of economics see: Robert A. Blecker’s “Financial Globalization, Exchange Rates, and International Trade (2003) http://www.american.edu/cas/econ/faculty/blecker/financial-revised.pdf
Blecker says this generally, as introduction: "International economists entered into the brave new world of financial globalization and floating exchange rates with analytical apparatus inherited from the past that ill equipped them to anticipate what that new wolrd that they had promoted would actually be like ... extreme volatility of exchange rates, persistent violations of purchasing power parity, chronic trade imbalances, repeated financial crises, and more internationally correlated business cycles....
At a minimum views like Bleckers need to be discussed on these pages...
Posted by: Dabbler Dave on March 23, 2004 09:25 AMDarn, nothing like the combination of massive debt overhang and a Kondratieff Winter to completely muck up Keynesian economic theory!
Posted by: Over Here on March 23, 2004 10:26 AMI think it weird to describe the article as weird. It could have been written by Milton Friedman; i.e. "cheap money" = dear goods and services (not low interest rates).
Posted by: Patrick R. Sullivan on March 23, 2004 08:55 AM
For once I find myself completely in agreement with Mr. Sullivan. In reality, this article isn't too much different from the opinion already discussed several times on this very site by such iconoclasts as Stephen Roach of Morgan Stanley, and the European Central Bank directors. Indeed, Brad doesn't agree and he may be right in his disagreement, but that doesn't make the thought a bizarre one does it? My own feeling is that mainstream economists are getting funny feelings right now because things are very funky with the economy, and not proceeding according to previously worked out patterns, what with the continued joblessness, high consumer debt, and huge trade deficit- somehow I don't think we're in 18th century London anymore, Mr. Smith...
Posted by: The True non economist on March 23, 2004 03:47 PM"Brad is ... right that rates have to remain low while job growth is so weak - a sudden increase would worsen job market conditions and jeopardize the recovery, such as it is. In any case, the REAL interest rate is not that low - somewhere between 0.5% and 1.0%, depending on how you measure it."
But, job growth might not be so weak (am I too big to say, "I told you so"? Ha ha, what do the usual suspects think):
http://economics.about.com/cs/macroeconomics/a/jobless_recov.htm
---------------quote-----------------
are we evolving into a free-agent nation in which fewer and fewer of us are engaged in traditional employer-employee relationships and more and more of us are available to organizations on a plug-and-play basis as freelancing independent contractors? Is our economy evolving into one in which traditional employment is going the way of the dinosaurs? Will many of us be used by employers on a plug-and-play basis? -- "I need you now, you're hired as a contractor; I don't need you now, bye. See you next time I need you."
Here's what I noticed in our data that supports the idea. Last tax year, in 2002, 4.2% of our compensation payments went to independent contractors (i.e. individuals who received a 1099 tax form) and the remainder went to employees (i.e. individuals who received a W2 tax form). This 2003 tax year, we are tracking on 4.7% of the total going to independent contractors.
As such, we see a statistically significant uptick in the use of independent contractors at small businesses.
Interestingly, Andrew Sum, the director of Northeastern University's Center for Labor Market Studies sees the same pattern. His analysis suggests that use of independent contractors explains the 3.1-million-job difference
between employment calculated via the government's payroll survey (which is
oblivious to independent contractors) and the government's household survey (which asks about independent contractors). The gap in the two employment reports is about 10 times the average gap found after the previous five
recessions, historically unprecedented according to Sum who believes that people are turning to informal contracting relationships to get by -- living off the land so to speak -- more than ever before.
-------------endquote-------------
No. Dr. Delong has it about right. The article is weird. It mistakes an instrument for an objective and thereby reveals the author's ignorance.
Keep the good work.
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