Who Knows the Neutral Rate of Interest? Not the Fed
In order to reach the neutral interest rate and hence price stability, writes Frank Shostak, the central bank must be forward-looking. But Bernanke's assessment of the future course of the economy may turn out to be wrong. Even if he is right on fundamentals, he could still be wrong on monetary policy's time lag, which tends to shift. Then the Fed ends up chasing its own tail. FULL ARTICLE
Comments (9)
Bernanke's attempts to accurately assess the future economic course will be fraught with inaccuracy regardless of whether he consults Keynesian economic texts or whether Madame Zelda reads interpretations from a crystal ball at a county fair. The only relevant question pertains to exactly what kind of a mess is he going to cause in the economy. If he does nothing and also stops the printing presses that crank out the dollar bills (the political masters in Washington won't let him), the fed would do less harm to the economy over the long-term future than any other fiscal policy initiative that they could conceive.
Published: May 17, 2006 12:09 PM
The funny part is the simplest solution is also the best for both congress and the fed. That is to stop!!! Just go home and collect your higher than average paycheck for doing nothing. Everything else is worse!!!!!
This is especially true for the Fed. If they just stop the US will enter a recession as it adjusted to the huge increases in money supply in the past 20 years. After this correction that has already started, the growth will start and proceed in a moderate pace with the growth in the economy.
Published: May 17, 2006 12:58 PM
Why do we make the implicit assumption that either the FedRes, or the USGov are acting in "our", the people's interest?
If we cast aside that assumption, do we not get a much more clear idea of what is afoot?
Many, maybe many of us, know and have known that the FedRes does best by doing little. Have they? Are they stupid? Hardly.
Same with the USGov, too, no?
TJ, now 263 years past his nascence, gave birth to all the PoliSci we need to know: "Government governs best, when it governs least."
And, FDR, master politician he was, gave us this insight: "Nothing in Politics happens by accident."
We can go on with our Normative cures, but until we give view of the negatives in the Positives about us, we might as well keep it short.
Published: May 17, 2006 1:33 PM
Anyone care to take a guess at the neutral rate of interest?
Published: May 17, 2006 11:15 PM
Interest rates should be determined by the rate at which people are willing to give up access to their savings (and risk losing them if a borrower defaults).
There should be no book keeping tricks by banks and other financial institutions to try and increase the amount of money lent out so that it is greater that real savings. All borrowing should be from real savings.
If one person wants a borrow a hundred Dollars they must find (or have a financial institution find for them) a person willing to give up one hundred Dollars of their income.
The rate of interest on this deal is partly about not having access to this money (as one has lent it out) - i.e. time preference, and partly about the risk of default (which will depend on the borrower and what they intend to do with the money). This is one reason why there are many different rates of interest.
Although a proper examination of time preference includes the risk of not getting the money back at all - i.e. default.
If I (or anyone else) have lent money out, we do not have this money to spend on other things (or to put in a box and look at from time to time).
Book keeping tricks that try and get round this will only set off a boom-bust cycle (as they have done in the United States since at least 1819).
Playing such games is fraud (whatever the statutes say).
As for the Fed - it should not exist. Nor should any government prop up system for the fractional reserve banking system (whether it is called the National Banking Act of 1861 or anything else).
If they Federal Reserve Board does exist it should not buy financial instruments or lend out money in any shape or form.
If it has to lend out money it should do so at an infinity rate of interest (which should discourage people from borrowing from it).
"But our fractional reserve banking system and the politically connected corporations depend on these games".
Oh dear, how sad, never mind.
Published: May 18, 2006 6:17 AM
Indeed. An artificial interest rate diverts capital from productive, low-risk enterprises into more speculative, less sound investments; it's a false market signal, since a low interest rate in a free market indicates an abundance of capital. The result is inefficiency and economic contraction.
Think of all the resources and labour spent on unproductive tech ventures during the dot-com bubble. Under a market lending rate, only the best of those investments (the eBays and Googles) would have gone ahead, while other industries made better use of the remainder.
What is the neutral rate of interest, Walkowsky asks? If the Fed sets its rate high enough that everyone borrows from private markets instead, you'll know it's been reached.
Published: May 18, 2006 7:33 AM
"All borrowing should be from real savings."
As it was back when half of all Americans lived in gut wrenching poverty and only rich people had savings.
Published: May 19, 2006 11:03 AM
M. E. Hoffer, never attribute to malice what can be attributed to ignorance.
Published: May 19, 2006 1:34 PM
TGGP,
Your premises, Bitte!
Published: May 19, 2006 1:49 PM