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.