Yesterday I was teaching on money in macroeconomics, and we discussed how the Fed influences the whole complex of interest rates. That naturally led to the question, how does the Fed “know” what the right level of reserves are, what the correct Fed funds rate should be, etc. What we know for sure is that the interest rate is a price, and therefore is a communication signal to millions of agents on how best to coordinate consumption across time. Setting the interest rate is really nothing different than any other price control, although its much worse given its more universal scope–e.g., I don’t think we’ll have too much economic mischief by the government putting some price control on tootsie rolls. But what we know about any price control, is its either unnecessary (if the government somehow got the price right, it would just be what the market would have done anyway), or that for political reasons, since we don’t like the market price, we’re going to create shortages (rent control) or surpluses (minimum wage). We find systematic bias in government for politically favored prices; e.g., the minimum wage will always be set above what the market price would be.

With interest rates, the political bias is almost always to have them lower. It is the very rare politician who will call for sound money. So what’s the problem with this? Just as with rent control and minimum wages, there are all sorts of unintended consequences–usually goring the ox of those pushing for it. Minimum wage harms poor and minorities the most. Rent control typically subsidizes the rich in expensive areas (the houses that stay) while the poor find their homes continually deteriorate as the demand for even shoddy housing will be great enough to rent a rat trap. And in the monetary world, we see–that is, if we have eyes to see–similar bad results.

So progressives like Bernie Sanders are outraged currently that firms are using their profits to do share buybacks, rather than investing in their companies and creating more high-paying jobs. Yet it’s worse than Sanders understands, in many cases these firms are not using profits to buyback their shares, but rather are borrowing money to do share buybacks. They are using the leverage of debt to decrease their shares outstanding–which gives the appearance of rising profits (since the same profit over less shares increases earnings per share). Executive compensation is often tied to this, especially as the stock price rises. Why do they do this? Because interest rates are so cheap. If the Fed didn’t have artificially low interest rates (especially earlier in this decade), we’d have seen less of this. Likewise, the tax deductibility of debt service but not dividends gives an artificial incentive to be more leveraged.

Then the biggest boogeyman of all for some is the idea of wealth inequality; Elizabeth Warren wants to have a wealth tax to handle this “problem.” Now there are a whole host of problems with this, some of which are listed here, but my point today is that wealth inequality is in large part driven by the easy money policies of the Fed. Lower interest rates make every future dollar earned more valuable, which increases every asset’s value. So when the moribund Obama economy saw the stock market triple, it was in large part a response to the monetary environment. I shouldn’t have to tell any of this blog’s readers which income class benefits more from lower interest rates which drive asset valuations higher.

Conservatives likewise bemoan the explosion of government debt over the last decade, but low interest rates mask the cost of government. It even creates a push that the markets “want” more government debt.*

But in typical fashion, government created problems become the excuse for more government to fix them. I have a better idea–how about we actually try markets and freedom for a change?

* I can’t find it w/google right now, but trust me that Former Fed vice chair Alan Blinder made this argument in WSJ op-ed a few years ago.