Former Fed Vice Chair encourages patience on rate hikes. Beyond the bad economics, have we thought through the morality of zero interest rates?

Former Vice Chairman of the Federal Reserve board joined the chorus of Wall Street cheerleaders saying the Fed can afford to be patient with raising interest rates earlier this week.  His rationale? Inflation as measured by the consumer price index or the Fed’s favored measure is very low:

The so-called hawks, who have been calling for rate hikes since 2009, have constantly warned of high inflation lurking just down the road. It must be a long road. The Fed’s favorite measure of core inflation (which omits food and energy prices) has been stuck in a narrow range between 1.3% and 1.7% since mid-2012. Headline inflation, which includes food and energy prices, is roughly zero. If the rationale for interest-rate hikes is heading off inflation, this performance practically cries out for patience.

Of course, this is the triumphant cry of all Keynesians:  “You free market types all said we were going to have hyperinflation and you were dead wrong.  So obviously there is nothing wrong with what we are doing.”  While there is no horse so dead that it cannot be beat some more, let’s quickly get past this idea.  First, by the time inflation manifests itself in consumer prices you have a really big problem.  The bigger problem is the capital misallocation that precedes CPI inflation is ignored consistently by Keynesians (principally because Keynesians don’t have solid capital theory).  Second, no critics ever put a timeline on how long this process builds up.  To say that we haven’t seen a problem yet, so therefore there is no problem, is akin to a man driving toward a cliff with no brakes.  The fact that he hasn’t suffered any ill consequences yet is no proof that a significant problem is not going to happen.   Third, the primary reason why consumer inflation has not yet occurred is the Fed’s balance sheet expansion has primarily landed as excess reserves on the banking system’s balance sheets–the banks are not loaning the money out, because the Fed is now paying them a small .25% interest rate.  Not much, but .25% annually of almost $3T in excess reserves adds up to significant money.  This raises a serious question that Keynesians don’t seem to ask:  if the Fed is effectively sterilizing their expanded balance sheet by paying interest on reserves, why are they doing it?  Isn’t the whole point of monetary policy to expand the money supply to get the banks extending credit broadly?  Its tempting to think the only purpose of the Fed’s policy is to boost financial asset prices and keep government funding costs low.  The result of this policy is to make the Top 1% richer and inequality greater.  Mr. Blinder has literally written books on income inequality and it is for him a great concern.  Yet the policy he advocates leads to a result he decries.

But let’s get beyond the economics, since Keynesian and free market economists are never going to see eye to eye on this.  Let’s think about the morality of zero interest rates.  Savers in this country have not been able to earn any return for ~ 6 years.  And while inflation is relatively low at roughly 2% per year, this means year in and year out savers are not only not earning any return, they are having an inflation tax of 2% annually.  Perpetual low interest rates (which are not a function of real economics supply and demand fundamentals) discourage saving and encourage consumption.   Sound economics and sound moral thinking encourage abstinence and rewards waiting, but our current monetary policy steers us to ever more “live for the day,” since trying to do well for tomorrow makes you an enemy of the Keynesian stimulus mentality.  Keynes himself called for this, by advocating for the euthanasia of the “rentier” class.  Without saving, there is no real investment, and without investment, there is no long term growth.  And we wonder why we are in the “new normal” of 2% growth?  A culture that fosters “live for the day” policies will not have much of a tomorrow.

19 thoughts on “Former Fed Vice Chair encourages patience on rate hikes. Beyond the bad economics, have we thought through the morality of zero interest rates?”

  1. “Let’s think about the morality of zero interest rates. Savers in this country have not been able to earn any return for ~ 6 years ,.”

    Only if savers are foolish enough to just let their money sit in the savings accounts.

    There have been PLENTY of opportunities, and not just in risky investments such as stocks, for savers. The array of financial products available to savers has arguably never been greater.

    In a time when cash is not in short supply[Apple alone has something close to $170 BILLION on hand!}, why should savers be entitled to great levels of unearned income?

    1. “Why should savers be entitled to great levels of unearned income?”
      1. I don’t think anyone is entitled to much of anything, certainly not entitled to “great levels of unearned income.” The point is that we should let markets decide what the reward to saving is based on how highly consumers value the product of the savers. I don’t trust anyone to be God to determine what is an appropriate level of the interest rate–that includes you, me and Janet Yellen. Central planning is a demonstrable failure around the world, and you think that perhaps the most importance price in the economy, the interest rate, can be determined by elites? Maybe you do–I certainly don’t.
      2. “Only if savers are foolish enough to just let their money sit in the savings accounts.” Do you have no compassion for the elderly who should not invest in more risky alternatives? I have aging parents who depended on some small savings interest to supplement their social security. Uncle Ben and Aunt Janet say they shouldn’t be allowed this savings–they must instead put their investment $$ in things we think are more appropriate, such as the stock market. Apparently you agree with this approach. I obviously don’t.

      1. ““Only if savers are foolish enough to just let their money sit in the savings accounts.” Do you have no compassion for the elderly who should not invest in more risky alternatives?”

        Oh, brother.

        I point out that there are other alternatives to having money and now my compassion towards the elderly is being questioned?!

        Give me a break.

        I am blown away that a PROFESSOR who teaches BUSINESS at an accredited university does not know that there are alternatives to a savings account that throw off some interest and do not endanger the principal.

        If you ask nicely (for a change), I would be happy to offer some advice. Seriously.

        If you already know there are alternatives, why again did you respond to my post?

  2. “Of course, this is the triumphant cry of all Keynesians: “You free market types all said we were going to have hyperinflation and you were dead wrong. So obviously there is nothing wrong with what we are doing.” While there is no horse so dead that it cannot be beat some more, let’s quickly get past this idea. First, by the time inflation manifests itself in consumer prices you have a really big problem. The bigger problem is the capital misallocation that precedes CPI inflation is ignored consistently by Keynesians (principally because Keynesians don’t have solid capital theory). Second, no critics ever put a timeline on how long this process builds up. To say that we haven’t seen a problem yet, so therefore there is no problem, is akin to a man driving toward a cliff with no brakes. The fact that he hasn’t suffered any ill consequences yet is no proof that a significant problem is not going to happen.”

    If someone has been wrong–dead wrong–for counting on six years now, why should they get the benefit of the doubt?

    After all, if one values REAL-world results, why should one listen to Chicken Littles? Why haven’t I heard many apologies–actually, I haven’t myself heard any–from people like Peter Schiff and other doom and gloomers?

    Everyone is wrong sometimes, but there is no rule that one must STAY wrong, and that one should not accept responsibility for their wrong [and free] choices.

    In the REAL world, timing means everything, and six years can be seen as a lot of time for one to wait to EVENTUALLY be right.

    Of course past results do not necessarily predict future ones. But one cannot ignore the fact that the “Keynesians” have been pretty spot on, and that those who predicted doom and gloom have been dead wrong.

    Considering your defense of Indiana’s [original[ Religious Freedom Act, I would not necessarily classify you as a consistent free market supporter. That is OK–no one’s perfect!

    1. Did you short the last two bubbles? I did…my timing stunk, I certainly don’t have omniscience. As one commentator said of bubbles, they grow bigger than you could ever think, and then double. This nonsense is not my first rodeo. You are of course free to keep driving happily to the cliff.

      As for your last comment, “considering your defense…,” I did not explicitly support that law in my two comments to Mark Smith, rather I poked at couple of implications of his analysis. Nevertheless I am generally in favor of freedom of association and to the extent the original RFRA law allows that, I support it. I think free markets is exactly that–free. sellers and buyers are free to enter into mutually beneficial trade, or free not to. Perhaps you think free markets means “coerced.” You are free to think that; of course that does not make it true.

      Edit: one more note, you say that “If someone has been wrong–dead wrong–for counting on six years now, why should they get the benefit of the doubt? After all, if one values REAL-world results, why should one listen to Chicken Littles? Why haven’t I heard many apologies–actually, I haven’t myself heard any–from people like Peter Schiff and other doom and gloomers?” I’ve challenged you before on this: show me an Austrian monetary economist that has predicted this? You continue to want to paint serious economic thought with pop press. Better yet, show me where I have predicted this for 6 years and been dead wrong. My consistent refrain is “this isn’t going to end well.” Because the one thing I’ve learned from both a theoretical and practical standpoint is that monetary mismanagement can go far longer than you would ever imagine.

      1. “I think free markets is exactly that–free. sellers and buyers are free to enter into mutually beneficial trade, or free not to. Perhaps you think free markets means “coerced.” You are free to think that; of course that does not make it true.”

        Who is being coerced to buy or sell anything?

        How can it be a truly free marketplace (where sellers can get the most when they sell and where buyers can get something for the least) if one can choose not to sell to someone who has a proven ability to pay? Hint–it cannot.

        May I remind you that your defense of RFRA is reminiscent of the so-called free market defenses of Jim Crow (“As a business owner, I can choose not to let blacks in my restaurant if I don’t want them”). Seriously. Do you really want to go back down THAT path?

        “Better yet, show me where I have predicted this for 6 years and been dead wrong.”

        Did I say this? No. So stop straw manning me already. If you are going to argue, do so honestly.

        “I’ve challenged you before on this: show me an Austrian monetary economist that has predicted this? You continue to want to paint serious economic thought with pop press.”

        Um, Jeff (sounds weird), where above did I say ANYTHING about Austrian monetary economists? I can show you some bad predictions from conservative economists and academics linked with the American Enterprise Institute, like the ones who signed that now-embarrassment of a letter to Ben Bernanke back in November 2010. Remember, the one that said that the Fed easing would ” risk currency debasement and inflation” and will not likely “achieve the Fed’s objective of promoting employment”?

        Obviously if you lost shorting the last two bubbles, THEY WEREN’T BUBBLES. :-)
        Too many so-called investors/traders THINK they know bubbles. They don’t. They see bubbles everywhere (except usually in gold, which is always too low and reday to break out to the upside), and even if they did, most lack the talent to know WHEN to short them. They’d rather [try to] be right than make money and cannot separate their egos from their decision-making process. They try to short “the top” and instead keep shorting consolidations in a bull trend.

        When I was young and naive, I did the same. Hope you learn from your mistakes.

  3. I’ve never quite thought in these terms before. It seems rather complicated, but also simple enough that the leading economists would have to be either entirely ignorant of a major issue or deliberately ignoring this topic. How strange!

  4. Like we have been talking about in class, it is very unfortunate that the government wants to penalize savers right now with all-time low interest rates. It makes consumers not even want to save money really and more invest in stocks and bonds. The Fed needs to get back to where our savings interest rate helps people and not penalizes them.

    1. I completely agree with you. Consumers get skeptical of when and how they should save and invest their money when they might be penalized.

  5. This is an interesting article. I like your second point because no one ever has incentive to do anything unless you have a time limit on it, and since they don’t it makes it seem hopeless to resolve in a sense. Its also funny how Blinder’s books contradict to what he is doing. Good article!

  6. It is very unfortunate that the government is effectively penalizing those who wish to save to help with a “better tomorrow”. How do we expect to grow our economy with these policies?

  7. It’s a shame that those who wish to save their money for future investments are being punished by the Fed’s decision to keep the interest rates low.

    I liked your comparison to a man driving off of a cliff, when you think about it that way it becomes much more imminent that these problems be solved!

  8. I find it interesting that the Fed fails to promote more saving, and that honestly upsets me a little bit. When I look at my bank account and see that I receive $.01 a month worth of interest, I just laugh because I know pathetic that is, and it doesn’t have to be like that. The Fed knowingly manipulates that, and it’s doing more harm than good for not only individuals uninterested in placing their money in risky markets such as stocks and mutual funds, but the economy as a whole.

  9. I liked your example of the man driving with no brakes and feeling secure until a problem actually occurs. I also agree that penalizing savers with low interest rates that are counteracted by inflation can lead to some serious investment problems in the future.

  10. It is unfortunate that those who are saving, lending money to the bank, are instead loosing money. This is encouraging spending and encourage debt.

  11. I do not understand why the government penalizes savers so much. It does not make much sense to me. The government’s agenda does not seem to align with promoting saving.

  12. It will become less and less enticing for those to save money when interest rates are kept at such a low rate. If the Fed wants to promote saving, it has to hike up interest rates soon. Our economy isn’t going to get back on track until Yellen and Co start this process.

  13. I agree with what the majority of my classmates have commented. It’s often said that there are two kinds of people in the world: savers and spenders. I happen to be the ladder. So, as someone who likes to make money and then save it for a time when I may need it, I don’t like that by saving money Americans are being penalized.

  14. A country that wants to grow in the long term needs to save in the present. With low interest rates, Americans are discouraged to save and as result the country doesn’t grow economically. I just hope that American politicians won’t wait for another recession to start doing something to change this situation.

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