William White, a brilliant Canadian economis
William White writes:
Mr White’s central thesis is that central banks affect the financial system much more directly than they affect the real economy or even nominal variables such as the rate of PCE inflation or the level of NGDP. As a result, there are times when stepping on the monetary gas pedal does not produce the desired results. During a balance sheet recession, the collapse in interest income hurts savers more than the decline in rates helps prospective borrowers. The collapse of the yield curve threatens the viability of intermediaries and can actually constrain credit creation. The expansion of central bank balance sheets threatens the functioning of the shadow banking system by depriving it of safe collateral. Instead of helping solve the immediate problem, it is possible that central bankers have actually been making it worse. And, of course, there is the possibility that today’s monetary policy is planting the seeds for another bubble.
Despite these sensible warnings, Mr White never argues for a sudden change in policy. Rather, he seeks to provide a context for thinking about the tradeoffs that central banks have made and will have to make in the future. Disappointingly, the establishment has not been receptive to this line of thinking. They should not be so quick to judge. Who knows who will be remembered as the modern-day Ptolemaists when the history books are written?http://www.economist.com/blogs/freeexchange/2012/09/perverse-effects-easy-money?fsrc=scn/fb/wl/bl/WilliamWhite
Wicksell was a pre-Keynesian macro theorist who offered a way to think about booms and slumps in terms of the difference between the market rate of interest and the “natural” rate, defined as the rate that would match desired saving and desired investment at full employment; there’s a boom when the market rate is below the natural rate, a slum when the reverse is true.
Let me just add that White and others seem in addition to be victims of the fallacy of immaculate inflation. As Karl Smith said in the linked piece,http://krugman.blogs.nytimes.com/2012/09/04/natural-born-recovery-killers/
Inflation must proceed through market processes. Demand for some product must rise or supply must fall.Any attempt to tell a story about inflationary risks that does not explain where excess demand for goods comes in is, necessarily, monetary mumbo-jumbo.
And yet there are significant forces out there using this mumo-jumbo to argue against policies that might help bring about recovery.
William White writes:
Ultra Easy Monetary Policy and the Law of Unintended Consequences: Perhaps a good jumping off point for such analyses might be the pioneering work of Knut Wicksel[l]. He made the distinction between the “natural” rate of interest, which equalized ex ante saving and investment plans, and the “financial” rate of interest, set by the banking sector. Differences between the two were thought by him to lead to undesired price movements and/or to economic “imbalances”, the importance of which would depend on the size and duration of the differences between the two rates.
Were we to adopt this analytical framework, policymakers today would seem to have serious cause for concern. The “natural rate” of interest (real) for the global economy as a whole can be proxied by the potential rate of growth of the global economy, as estimated by the IMF. Reflecting globalization and technology transfer, this measure has been rising steadily for the last twenty years. In contrast, if one proxies the financial rate of interest (real) by an average of available breakeven rates (say for ten year TIPS), this measure has been falling for the last twenty years. Moreover, at the global level, the natural rate of interest rose above the financial rate in 1997, and the gap has essentially been widening ever since52. From this perspective, underlying inflationary pressures and/or “imbalances” have already been cumulating for many years. Since recent ultra easy monetary policy initiatives are effectively “still more of the same”, there would then seem to be a prima facie case for raising concerns about the unintended consequences of monetary easing…
William White says that the natural rate of interest is above the market rate. But he is wrong: we don't see businesses dipping into their cash reserves to find investment, a monetary hot potato, unexpected and rising inflation, and full or over-full employment.
Instead, we see elevated unemployment and firms and households adding to their cash reserves. This is what Wicksell expected to see when the natural rate of interest was below the market rate: planned investment would then be lower than desired savings, households and businesses seeking to save would be unable to find enough bonds to balance their portfolios, they would then transfer some of their cash out of transactions balances and treat them as unspendable savings (the "precautionary" or "speculative" demand for money), we would see too little money to buy all the goods and services that would be put on sale at full employment, and we would see no signs of inflation but a depressed economy.
That is the root of our problem: the natural nominal rate of interest--the rate of interest that balances planned investment (plus etc.) and desired savings (at full employment, plus etc.)--today is less than zero, and so the Federal Reserve cannot push the market nominal rate of interest down low enough. The alternative solutions are (i) DeLong-Summers expansionary fiscal policy which raises the natural rate of interest up to the market rate and rebalances the economy so it can attain full employment; and (ii) Woodford-Krugman-Eggertsson raise-inflationary-expectations policy that raises the nominal rate of interest up to the market rate and rebalances the economy so that it can attain full employment.