We’re talking about the argument that the US economy has collapsed into so-called secular stagnation, a more or less permanent period of slow growth, high unemployment and very low interest rates. We’ve looked at several of the arguments put forth by the secular stagnationists, and in this post we’ll evaluate the claim that the plague of secular stagnation is upon us in part because central bankers have exhausted their arsenal of growth-enhancing weapons.
The central banker-exhaustion argument is best illustrated by a simple example. Imagine a time when the fed funds rate(1) is at a more normal level – say, 5%. If the US economy begins to tip into recession, the Fed has a lot of “firepower” at its disposal. Since the Fed typically lowers rates slowly, maybe one-quarter or one-half per cent at a time, it can do a lot of lowering. In fact, historically, the Fed has reduced rates 4% or so during recessionary periods.
But if the fed funds rate is already at or near zero, as is the case today,(2) the Fed has very little firepower left, or so goes the argument. While rates can theoretically go below zero, in reality, positive rates are necessary for economies to operate.(3) In central banker circles, this is known as the “zero bound problem.”
Unfortunately for the secular stagnationists, there are many problems with the central banker-exhaustion thesis. For example, what about unconventional policies like quantitative easing? It’s odd, indeed, that the secular stagnationists don’t mention QE, since they have been its most enthusiastic proponents. But Milton Friedman himself pointed out that zero interest rates aren’t a limitation, because the Fed can simply keep buying bonds.
Perhaps the proponents of secular stagnation have observed the dismal results of QE and decided it’s best to ignore the technique. But there are many other unconventional techniques central bankers could employ, and the Fed has confirmed that these techniques exist and could be rolled out.
True, the Fed hasn’t said exactly what other unconventional techniques might be, but we don’t have to be central bankers to dream some up. Let’s start with Friedman’s idea of having helicopters drop money down on a happy citizenry. Friedman introduced the idea back in 1994,(4) but in our tech-happy world we can vastly improve on it. Suppose the Fed rents thousands of helicopters to drop millions of one thousand dollar bills on America’s one hundred largest cities. So far, so Friedman.
But these aren’t ordinary one thousand dollar bills, like, say, the one thousand Swiss franc notes you use to buy a Löwenbräu in cafes along the Bahnhofstrasse. No, if these one thousand dollar bills aren’t spent in ten days, they convert themselves to one dollar bills. In mere days, the economy is booming!(5)
But the primary problem with the central banker-exhaustion argument is the breathtakingly solipsistic mindset behind it. To worry about central banker exhaustion, you first have to believe that economies can’t function without the tender ministries of the bankers. Indeed, engraved above the entrance to every central bank building in the world is the legend, “Sans nous, le déluge.”(6)
Since the US economy functioned well for roughly 137 years before the Federal Reserve System was organized, this seems like the sort of idea only an economist could believe. That’s not to say, however, that there aren’t important constituencies that pretend to believe the notion that we couldn’t survive for an hour without the Fed. (I don’t count economists themselves, an unimportant constituency.)
There is, for example, Congress. A Congressperson might approve or disapprove of whatever the Fed’s doing, but since Congress has no intention of doing anything itself, and since it doesn’t want to take any heat for doing nothing, it’s crucially important for Congresspersons to pretend to believe in the indispensability of the Fed.
And then, of course, there is the financial industry. Because the Fed can make asset prices go up or down at will (by using its unlimited checkbook), the financial industry views the Fed as omnipotent in its narrow little corner of the world. The adage, “Don’t fight the Fed,” can be re-translated as “Suck up to Fed and praise it to the skies so it’ll keep prices going up instead of down.”
Unfortunately for the central bankers, that leaves 324 million ordinary American citizens who take a very different and much dimmer view of the Fed. These people don’t much own stock and therefore don’t much care whether the Fed makes prices go up or down. They aren’t addicted to irresponsibility, so they don’t sit in Congress and aren’t looking for someone to do their jobs for them. The notion that a small handful of over-educated professors can manage the economy better than millions of consumers strikes them as fatuous.
What these folks care about is the underlying economy, and on that front the Fed’s track record is dismal. The Fed has promised a strong economy – above 3% GDP growth – for seven straight years, and they’ve been wrong seven straight times. What this suggests to ordinary folks is that Fed has no clue what it’s doing and needs to get out of the way and let the economy right itself.
In other words, if you don’t live in the hermetically-sealed, oxygen-deprived world of the macroeconomists and central bankers, the central banker-exhaustion argument is obviously lamebrained. And if you don’t work on Wall Street or in Congress, you don’t even have to pretend that it’s not lamebrained. We don’t, so we won’t.
The final argument of the secular stagnationists is that technological progress has slowed down, taking productivity and therefore strong economic growth down with it. We’ll grapple with that one next.
(1) The “fed funds rate” is an artificial interest rate established by the Fed’s Open Market Committee. It’s the interest rate at which banks with surplus balances at the Fed (i.e., bank reserves) lend funds to banks who need to bolster their reserves. The actual interest rate will fluctuate around the rate set by the Committee, as the rate is enforced not by law but via the New York Fed’s open market operations.
(2) The fed funds rate has been set at 0.25% by the Open Market Committee, but the effective rate is closer to 0.10%, presumably due to lack of demand.
(3) See my four posts “On NIRP,” discussing the phenomenon of negative interest rates, beginning with the post of 4/2/15.
(4) Friedman, Money Mischief, Chapter 2, “The Mystery of Money.”
(5) Naturally, I’ve copyrighted this idea, so when the Fed finally gets around to implementing it they’ll have to pay royalties.
(6) Sorry, I meant to say that the legend is engraved on the brain of every central banker.
Next up: Slow Recovery or Secular Stagnation? (Part 6)
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