Scott Sumner  

The WSJ's odd critique of the Fed

PRINT
The Huemer Graph... Canada Can't Dodge Two Bullets...

This article in the Wall Street Journal left me scratching my head:

The Fed, Not the Market, Is Stifling Growth
That's the title, and I eagerly looked forward to an explanation, perhaps a criticism of the Fed rate increase last December. Instead I found this comment:
Fed policies of zero interest rates and bond buying--quantitative easing--have not only failed to stimulate business investment. They have discouraged it through the misallocation of capital. This is contractionary because it starves entrepreneurship and thus productivity growth.
Well that's certainly an unconventional hypothesis. But being unconventional doesn't make it wrong--lots of my ideas are also unconventional. At this point a good newspaper would normally provide an explanation for their unconventional claims. This is what we get instead:
The North American Free Trade Agreement (Nafta) opened the Mexican economy to Canadian and U.S. imports in 1994. Many Mexicans lost jobs. Yet the country gained access to what it needed to modernize. Running water, salmon entrees, California wines and air conditioning were not standard fare here on the Mayan Riviera in 1985. They are now, and tourism has boomed.
Elite newspapers generally have editors. I wonder how the WSJ editor could have let that slip by. It does not seem to support the unconventional claim regarding monetary policy. Further along the essay does return to the Fed:
Left out of their analyses is the gargantuan role of the Federal Reserve's antigrowth monetary and regulatory policies. Mr. Trump argued in September that the Fed's eight-year policy of cheap credit is generating asset bubbles. But if he understood the problem he wouldn't rail against Nafta.
So is that the explanation--an appeal to authority? Because Mr. Trump said so? But then why follow it up by disparaging Trump's knowledge of economics, which suggests that he is in fact not an authority?

And even if Trump were right, why would an asset bubble reduce investment? The usual theory of asset bubbles (which I do not buy) says they boost investment (tech in 2000, housing in 2006, etc.) Again, no explanation.

Conventional wisdom holds that the Fed has flooded the market with credit by aggressively buying bonds and creating bank reserves on the Fed balance sheet. Yet when the Fed buys assets--such as government debt or mortgage-backed securities--it only records a short-term liability on the balance sheet. The reserves are on the books but don't create any more credit in the real economy than if the Fed never made the purchase. Meanwhile it creates shortages of medium- and long-term assets in the market.
Finally there is an acknowledgement that the conventional wisdom is different. But still no explanation of how Fed policy is discouraging investment. Plus there's a weird comment about a shortage of long-term bonds. Yet that's clearly false---I can go out and buy a Treasury bond any time I like. And even if we generously assume that the author is confusing "shortage" with "reduction in supply", there is no explanation as to why this would hurt investment. The standard textbook theory says investment is hurt when there is an increase in supply of government bonds. Indeed this theory, often called "crowding out of investment" is popular with conservative newspapers like the WSJ. So I'm still waiting for an explanation of how the Fed's policy is reducing investment.
If there were a glut of credit in the real economy it would likely show up in bank lending as expanding businesses clamored for low-cost loans. Yet credit growth "has been dismally slow," wrote David Malpass, president of the consulting firm Encima Global in a recent note to clients.
So credit growth has been slow. OK, but why link this to Fed policy? After all, haven't we just a massive banking crisis? Haven't banks just tightened their loan standards in the wake of the crisis? Haven't we had Dodd-Frank---a regulatory monstrosity? Why single out the Fed. In the very next sentence, the author seems to agree with me:
The term structure of bank assets is partly to blame, but so is regulation--by the Fed and Congress, via 2010 Dodd-Frank legislation--which has made it difficult to lend to businesses, especially small ones.
Thus it's not the low interest rate policy of the Fed, it's their "regulation". That sounds much more plausible.
The most creditworthy companies are using cheap money not in productivity-increasing ventures but to pay dividends, buy back stock or engage in other financial transactions. Fed policies, as Mr. Malpass wrote, are "reducing the credit available to smaller businesses and hurting GDP growth rather than stimulating it."
And that's it. An assertion that Fed policies are hurting business investment, but no explanation of how this is occurring. What is the mechanism? How does Fed policy discourage person A from extending credit to person B? You go all the way to the end of the article with a provocative headline, and the author doesn't even attempt to back up this unconventional claim. What a let down! I like contrarian arguments---I wish the WSJ had provided the contrarian argument that they promised in their headline. I can't criticize an argument that is not made.

This is the sort of article one gets when an ideology has reached the point of intellectual bankruptcy. The ideology is "Monetary policy is always and everywhere too expansionary." If you adhere to that ideology, eventually you'll have to tie yourself up in knots, attributing problems to "easy money" that are obviously not due to easy money. We've reached that point with the Wall Street Journal.

One can find many similar articles in conservative newspapers during the 1930s. I thought Friedman and Schwartz had put an end to that sort of conservatism. I guess I was wrong.

HT: Ken Duda


Comments and Sharing






COMMENTS (17 to date)
pyroseed13 writes:

"And even if Trump were right, why would an asset bubble reduce investment?"

Well here's one way you could explain this: Regulation and tax policy has hurt entrepreneurship in the U.S. In a less risk-averse and more economically free environment, savings would be flowing into new investments. But right now all that's happening is that this savings is being used to bid up prices on existing assets, mainly housing. So this asset bubble is reducing investment in other areas of the economy.

foosion writes:
The ideology is "Monetary policy is always and everywhere too expansionary."
I believe the ideology is "Monetary policy is always and everywhere too expansionary when a Democrat is President." Also, regulations which restrict the profits of the financial sector (or most major sectors) are bad, no matter what the benefits might be. Throw in that taxes on the best off are bad and you can predict just about every WSJ editorial regarding the economy.
Andrew_FL writes:
The ideology is "Monetary policy is always and everywhere too expansionary." If you adhere to that ideology, eventually you'll have to tie yourself up in knots, attributing problems to "easy money" that are obviously not due to easy money.

Looking upon one's mirrored image can at times be unsettling, to be sure.

LD Bottorff writes:

Do you believe the articles on the backside of the editorial page are reflections of the editorial board? There are several columnists, including William Galston, who write columns that are very much in opposition to the editorial board's opinion pieces.
You quote the paragraph beginning, "NAFTA opened the Mexican economy to Canadian and US imports" and then imply that there was a whopper in there that the editors should have caught. For the sake of your slower students, please explain which fact was in error. Did NAFTA not open the Mexican economy to more Canadian and American products? Was the modernization of the Mayan Riviera proceeding fine before NAFTA? Was the tourism boom inevitable, even without NAFTA? Or, were you just criticizing the editors because they didn't force Mary Anastasia O'Grady to bring make her point quickly enough?
Your paragraph beginning with "So that is the explanation..." makes no sense at all. Explanation of what? Whose authority? Do you really think Ms. O'Grady considers Trump an authority on economics?

There certainly are parts of O'Grady's column that are confusing, but your critique has me thoroughly confused. Do you think that free trade is bad? Do you think the Fed is doing everything right, but the pressure from immigration and free trade is keeping the economy from growing more quickly? Do you think the Fed really is independent? To me, what was clear about her article is that our economic problems are not caused by free trade or immigration, but that the Fed policies are more to blame. You close your post with the implication that she is part of the crowd that believes that monetary policy is "always and everywhere, too expansionary." I wonder if we both read the same article.

Don Geddis writes:

Bottorff: Just try to answer this one question: O'Grady clearly says that "Fed policies are ... to blame", as you agree. After reading the article, can you describe the mechanism by which this occurs? What is O'Grady's explanation, for exactly how current Fed policies cause our current economic problems? Forget about whether it is right or wrong; is there even a causal explanation of any kind?

(The reality is that she is defending free trade as not to blame for economic problems -- which is correct -- but then she shifts blame to Fed policies, without really understanding even her own claims.)

Sumner: You might enjoy the connection between NAFTA and avocados. 80 years of regulation, causing a net loss to society. NAFTA allows free trade, and the result is essentially a win for everybody. How convincing could one have been, in the early 90's, to predict the economic future of the avocado industry, with or without free trade? What would have convinced the anti-free-trade advocates, that their position was sorely mistaken?

Economics is not a zero sum game. Government really can make deliberate choices to make everybody poorer. And deregulation and free trade can have the potential to make everyone better off, at the same time!

LD Bottorff writes:

Don Geddis,
She writes (and credits David Malpass),
the most credit-worthy companies are using cheap money, not in productivity increasing ventures, but to increase dividends and buy back stock. Also, Fed policies are reducing the credit available to smaller companies.
This makes sense to me. Fed policies that provide cheap credit to established (or politically favored) companies that use the money to buy back (thus raising the price of) their stock, make it more difficult for smaller, newer, or politically un-favored companies to compete in capital markets. This provides an advantage to the established companies and reduces their incentive to innovate since the more innovative companies have less access to credit.
That isn't to say that her article is crystal clear. But Scott's critique confuses me even more.

Scott Sumner writes:

pyroseed, You said:

"But right now all that's happening is that this savings is being used to bid up prices on existing assets, mainly housing."

Savings cannot go "into" existing assets in net terms. Savings can only go into new investments.

Foosion, You said:

"I believe the ideology is "Monetary policy is always and everywhere too expansionary when a Democrat is President.""

Fair point.

Andrew, I've argued that monetary policy is too expansionary far more often than that is is too contractionary. From 1966-81 I consistently thought it was too expansionary. Ditto for the late 1980s.

LD, No, I agree with her on NAFTA, not sure why you assumed I did not. My point was that that paragraph was a complete non-sequitor. Her previous paragraph needed to be followed with an explanation for her highly unconventional claims about monetary policy. Instead she started talking about NAFTA.

You said:

"Do you really think Ms. O'Grady considers Trump an authority on economics?"

No, indeed I made clear she does not. So why cite him as an authority on why the Fed's policy slowed growth?

You said:

"This makes sense to me. Fed policies that provide cheap credit to established (or politically favored) companies that use the money to buy back (thus raising the price of) their stock, make it more difficult for smaller, newer, or politically un-favored companies to compete in capital markets."

I doubt this is true. But if you were going to make this claim, don't you think you should provide some sort of explanation? How does the Fed mysteriously direct credit away from small business toward larger business? The Fed controls monetary policy, not credit policy (except through regulation, and even I conceded that regulations may have reduced investment. I just don't get how low interest rates did this.

And why would big businesses buying back their stock make it harder for small firms to invest? I'd think that would make it easier, as firms buying back their stock are injecting saving into the economy.

Bob Murphy writes:

Scott,

Of course, your actual economic models are more rigorous than O'Grady's implicit model(s). But I think she is saying something like this:

(1) Other things equal, low interest rates reduce the quantity of genuine saving by households.

(2) Of the existing pool of genuine savings, the allocation mechanism of the interest rate doesn't serve its purpose when it it artificially held down. If the fed funds rate is supposed to be 2%, then that would prevent certain projects from being funded (which didn't have an IRR of at least 2%). But when the fed funds rate is pushed down to almost 0% for years and years, then all sorts of projects get funded that should not have been.

In your critiques of this sort of mindset, it seems you are adopting a framework that just looks at total investment, period, without looking into the different channels. Yet surely in the real world it matters a lot whether the economy has been diverting real resources into a balanced mix of nails, hammers, and lumber, as opposed to having "the same amount" of investment just in hammers.

James writes:

Scott,

You raise some valid concers with the WSJ article but that only touches the periphery of the issue and neglects a more central disagreement:

Some economists believe that in all markets, prices transmit information that allows participants in those markets to make sound economic decisions. Therefore if government institutions deliberately act to manipulate those prices, the participants in those markets will be operating from a reduced information set and this will lead to inferior economic outcomes.

Other economists believe that in all markets but one, prices transmit information that allows participants in those markets to make sound economic decisions. Therefore if government institutions deliberately act to manipulate those prices, the participants in those markets will be operating from a reduced information set and this will lead to inferior economic outcomes. Except for just one special case.

One that disagreement is resolved, I think everything else will more or less fall into place.

Kevin Erdmann writes:

Bob,

Your point number one is literally the definition of reasoning from a price change.

Your point number two seems to presume that the Fed's target rate has been below the neutral rate since the recession. Do you really believe that we would just be humming along with 3% short term interest rates if the Fed had just put them there 6 years ago? Isn't there pretty much a consensus that the zero lower bound prevented the Fed from "artificially" holding rates down?

Thaomas writes:

Wow! Are you only now discovering "macro media?" The rest of us have been hearing since 2008 that the Fed has been "debasing the currency" (Rick Perry even threatened violence if it did not stop) by holding interest rates too low and even worse buying long dated assets. What's worse the Fed has gone along, allowing the price level to drift ever farther from its 2% per annum growth.

Bob Murphy writes:

Kevin,

Your response to me assumes that the Fed hasn't been artificially holding down interest rates. Yes, if we assume that, then O'Grady's column is nonsense. But, some people disagree with you (and Scott) on this point, and I thought the objective here was to explain where people like that are coming from. They are not committing simplistic errors; it is entirely possible that households are saving less than they otherwise would have been.

Also, just a quibble, but: You wrote: "Isn't there pretty much a consensus that the zero lower bound prevented the Fed from "artificially" holding rates down?"

That's fine, but there is also a consensus that we've had really loose money since 2008. So are we going off the "consensus" now, or are we trying to offer different explanations for the awful economic performance we all agree has occurred since then?

Prakash writes:

I stumbled upon something weird when I was thinking for a while as an entrepreneur rather than as a policy maker.

If the interest paid on reserves is actually higher than the natural rate, then what is to prevent a really wealthy person from starting their own bank and stashing it with capital? They would be earning a safe rate that is higher than what they would earn otherwise in the market.

Is the market to entry in banking that steep? Are the regulations too cumbersome? Is this the equivalent of picking up pennies in front of a roadroller? (Too much risk for too little reward)

Andrew_FL writes:

You might consider explaining that to the Erdmanns and Coles of the world for whom Market Monetarism is cover for their inflationist ideology.

bill writes:

If anything, the Fed is "artificially" holding rates UP, not down. If I go to the market, I can get 0% for overnight money. 1 month T-bills pay 24bps, 3 month T-bills pay 33bps and 6 month T-bills pay 48bps. Only banks can earn 50bps for overnight money by depositing reserves at the Fed. Why is the Fed paying more to essentially borrow from banks than the Treasury is paying to borrow from everyone else in the world?

Mark Michael writes:

Brian Westbury on his US Bank website mentioned that when the Fed holds down the Fed funds rate and longer-term rates (I'd add artificially for a long time), it allows borrowers with less productive uses for those funds to risk borrowing them.

When rates are higher, they'd not take that chance. Potential borrowers who thought they had more productive uses for those funds would risk borrowing them. Averaged across a 320-million population & $17 trillion economy, that results in a lower real GDP growth rate by, oh, say 1% or maybe 2%. Hence, the anemic growth rate we've experienced for the last 6 years compared to other deep recessions, financially-driven or otherwise.

(I'm not an economist. I hope I accurately copied his somewhat casual thought here. Seemed pretty obvious to me.. I also think Prof. John Taylor and his Taylor's Rule makes sense for central banks to manage short-term interest rates. Interest rates are prices for money just as other items in the economy have prices. They serve the usual information-conveying function that prices of goods & services generally do in a market-based economy. Re: F.A. Hayek, et al. Prattling on, I think the last 45 years since Nixon closed the gold window in 1971 and First World countries all went to fiat currencies "prove" we should go to competitive commodity-based privately-run multiple-money system. Say gold, silver, platinum, & bitcoins. Having a government monopoly on something as critical as money seems odd to me. We'd never allow that for, say, cars. Or ice cream.)

bill writes:

I think Brian Westbury would then be reasoning from a price change.

Comments for this entry have been closed
Return to top