Archive for the ‘Monetary Policy’ Category

We’ve been suffering through the weakest recovery since the Great Depression. Labor force participation hasn’t recovered and median household income is stagnant.

So how are our benevolent and kind overseers in Washington responding?

Are they reducing the burden of spending? Nope, they just busted the spending caps (again).

Are they cutting back on red tape? No, they’re moving in the other direction.

Are they lowering taxes? With Obama in the White House, that’s not even a serious question.

But that doesn’t mean all the people in Washington is sitting on their collective hands. The folks at the Federal Reserve have been trying to goose the economy with an easy-money policy.

Unfortunately, as I argue in this recent interview, that’s not a recipe for success.

At best, an easy-money policy is ineffective, akin to “pushing on a string.” At worst, it creates bubbles and does serious damage.

Yet if you don’t like the Fed trying to manipulate the economy, you’re often perceived as a crank. And if you’re an elected official who questions the Fed’s actions, you’re often portrayed as some sort of uninformed demagogue.

I explored this issue today in The Federalist. In my column, I defended Senators Rand Paul and Ted Cruz.

Rand Paul and Ted Cruz…deserve credit for criticizing the Federal Reserve. …This irks some folks, who seem to think Fed critics are knuckle-dragging rubes and yahoos with a superstitious fealty to the gold standard.

This isn’t a debate over the gold standard, per se, but instead of fight over monetary Keynesianism vs. monetary rules.

The dispute isn’t really about a gold standard, but whether the Federal Reserve should have lots of discretionary power.  …On one side are the advocates of…the monetary component of Keynesian economics. Proponents explicitly want the Fed to fine-tune and micromanage the economy. …On the other side are folks who believe in rules to limit the Fed’s powers…because they believe discretionary power is more likely to give us bad results such as higher price inflation, volatility in output and employment, and financial instability.

And the Joint Economic Committee is on the side of rules. Here’s an excerpt from a JEC report that I cited in my article.

Well-reasoned, stable and predictable monetary policy reduces economic volatility and promotes long-term economic growth and job creation. Generally, ‘rules-based’ policies reduce uncertainties and facilitate long-term planning and investment. …Conversely, activist, interventionist, and discretionary monetary policies have been historically associated with increased economic volatility and subpar economic performance.

I then mention various rules-based methods of limiting the Fed’s discretion and conclude by commenting on the legitimacy of those who want to curtail the Federal Reserve.

Paul and Cruz may not be experts on monetary policy, just as left-wing senators doubtlessly have no understanding of the intricacies of discretionary monetary policy. But the two senators are on very solid ground, with an illustrious intellectual lineage, when they assert that it would be a good idea to constrain the Fed.

Now let’s expand on two issues. First, I mention in my article the gold standard as a potential rule to constrain the Fed. I’ve previously shared some analysis by George Selgin on this topic. He’s concluded that governments won’t ever allow its return and probably couldn’t be trusted with such a system anyway, but that doesn’t mean it doesn’t work.

Here are some excerpts from a recent article by George. Read the entire thing, but here’s the part that matters most for this discussion.

…the gold standard was hardly perfect, and gold bugs themselves sometimes make silly claims about their favorite former monetary standard. …the classical gold standard worked remarkably well (while it lasted). …it certainly did contribute both to the general abundance of goods of all sorts, to the ease with which goods and capital flowed from nation to nation, and, especially, to the sense of a state of affairs that was “normal, certain, and permanent.” The gold standard achieved these things mainly by securing a degree of price-level and exchange rate stability and predictability that has never been matched since.

And Norbert Michel of the Heritage Foundation touches on some of the same issues in a new column for Forbes.

Several candidates suggested the gold standard was a good system, and they’re all getting flak for talking about gold.

But here’s the most fascinating revelation from Norbert’s column. It turns out that even Ben Bernanke agrees with George Selgin that the classical gold standard worked very well. Norbert quotes this passage from Bernanke.

The gold standard appeared to be highly successful from about 1870 to the beginning of World War I in 1914. During the so-called “classical” gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value.

Both Norbert’s article and George’s article have lots of good (but depressing) analysis of how governments went off the gold standard because of World War I and then put in place a hopelessly weak and impractical version of a gold standard after the war (the politicians didn’t want to be constrained by an effective system).

So here’s Norbert’s bottom line, which is very similar to the conclusion in my column for The Federalist.

Many who favor the gold standard recognize that it provided a nominal anchor as opposed to the discretionary fiat system we have now. Maybe the gold standard isn’t the best way to achieve that nominal anchor, but we shouldn’t just dismiss the whole notion.

The second issue worth mentioning is that the best way to deal with bad monetary policy may be to have no monetary policy.

At least not a monetary policy from government. This video explains the merits of this approach.

Gee, maybe Friedrich Hayek was right and private markets produce better results than government monopolies.

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This century has not been good news for economic liberty in the United States.

According to Economic Freedom of the World, America has dropped from being the 3rd-freest economy of the world in 2001 to the 12th-freest economy in the most recent rankings.

Perhaps more important, our aggregate score has fallen from 8.20 to 7.81 over the same period.

So why has the U.S. score dropped? Was it Bush’s spending binge? Obama’s stimulus boondoggle? All the spending and taxes in Obamacare? The fiscal cliff tax hike?

I certainly think all those policies were mistaken, but if you dig into the annual data, America’s score on “size of government” only fell from 7.1 to 7.0 between 2001 and 2012.

Which means economic freedom in the United States mostly declined for reasons other than fiscal policy. In other words, our score dropped because of what happened to our scores for trade policy, monetary policy, regulatory policy, and property rights and rule of law.

That triggered my curiosity. If America is #12 in the overall rankings, how would we rank if fiscal policy was removed from the equation?

Here are the results, showing the top 25 jurisdictions based on the four non-fiscal policy factors. As you can see, the United States drops from #12 to #24, which means we trail 14 European nations in these important measures of economic freedom.

If you look in the second column, you’ll notice how many of those European nations have double-digit increases when you look at their non-fiscal rankings compared to their overall rankings.

This is for two reasons.

First, their fiscal scores are terrible because of high tax rates and a stifling burden of government spending.

Second, these same nations are hyper-free market on issues such as trade, regulation, money, rule of law and property rights.

In other words, the data back up points I’ve made about policy in nations such as Denmark and Sweden.

In an ideal world, countries should have free markets and small government. In Northern Europe, they manage to get the first part right. Which is important since non-fiscal factors account for 80 percent of a nation’s overall grade.

Now let’s return to the issue of America’s decline.

Here are the non-fiscal rankings from 2001. As you can see, the United States was #5 at the time, scoring higher than even Singapore and Hong Kong. And the U.S. was behind only three European nations back in 2001.

For what it’s worth, America’s score has fallen primarily because of a significant drop in the trade category (from 8.7 to 7.7) and a huge drop for rule of law and property rights (from 8.7 to 7.0).

In other words, it’s not good for prosperity when a nation begins to have problems such as protectionism and politicized courts.

P.S. The erosion of America’s score for non-fiscal factors is particularly disappointing since improvements in those factors have played a big role in protecting the world from the negative economic consequences of more spending and taxes.

P.P.S. I think this is an example of correlation rather than causation, but the above rankings for non-fiscal economic liberty seem somewhat similar to the rankings I shared last week looking at overall societal freedom.

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What’s the biggest economic fallacy on the left? What’s the defining mistake for our statist friends?

One obvious answer is that many of them hold the anti-empirical belief that the economy is  a fixed pie and that one person can’t climb the economic ladder unless another person falls a few rungs.

There’s no doubt that the fixed-pie myth is an obstacle to sound thinking, but I’m wondering whether an even bigger problem is the pervasive belief on the left that there are easy shortcuts to prosperity.

Keynesian fiscal policy, for instance, is based on the notion that more growth is just a simple question of having the government spend more money.

And Keynesian monetary policy is based on a similarly simplistic assumption that more growth is generated by having central banks create more money.

To be sure, both policies may seem to work in the short run since people suddenly perceive that they have more money. But perceptions and reality may be different, particularly if the short-run boost in the economy is an illusory bubble.

And that’s why I’m not a big fan of QE-type policies designed to “stimulate” growth with artificially low interest rates.

As I explain in this brief FBN interview, any short-run gain is offset by long-run pain.

And I’m not the only one who has a jaundiced view.

The Wall Street Journal also is not happy with the Federal Reserve, opining that the real economy has stagnated as financial assets have been propped up by easy money.

…the Fed has only itself to blame for its economic and political predicament. …One lesson here is that the Fed’s great monetary experiment since the recession ended in 2009 looks increasingly like a failure. Recall the Fed’s theory that quantitative easing (bond buying) and near-zero interest rates would lift financial assets, which in turn would lift the real economy. …But while stocks have soared, as have speculative assets like junk bonds and commercial real estate, the real economy hasn’t. This remains the worst economic recovery by far since World War II…the economic expectations of Fed Chairs Ben Bernanke and Janet Yellen have been consistently wrong. …the Fed now finds itself caught between a slowing global economy and its promise to begin normalizing rates this year. …One result has been to increase economic uncertainty and market volatility.

Another result is that easy-money policies give politicians an excuse to avoid the real reforms that would boost long-run growth.

I definitely think that’s been a problem in Europe. Politicians keep waiting for magical results from the European Central Bank when the real obstacle to prosperity is a stifling burden of taxation, spending, and regulation.

The bottom line is that politicians all over the world are exacerbating bad fiscal and regulatory policy with bad monetary policy.

To augment this analysis, here’s a video from the Fraser Institute about the insight of Friedrich Hayek, who warned that government intervention, particularly via monetary policy, caused booms and busts by distorting market signals.

Needless to say, last decade’s financial crisis is a case study showing the accuracy of Hayek’s Austrian-school analysis.

But politicians never seem to learn. Or maybe they just don’t care. They focus on the short run (i.e., the next election) and it always feels good when the bubble is expanding.

And when the government-created bubble bursts, they can simply blame greed, or rich people, or find some other scapegoat (and then repeat the same mistakes as soon as the dust settles).

P.S. For a more detailed look at Austrian economics, check out this lecture. And Austrian-school scholars also have the best analysis of the Great Depression.

P.P.S. And for a more conventional critique of easy-money policies, here are some highlights from a speech by a member of the Bank of England’s Monetary Policy Committee.

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Before getting to the main topic today, here are some excerpts from a New York Post story that patriotic American readers will appreciate.

It deals with a protest.

…the group Disarm the Police…had announced on social media that they had planned to burn the flag in protest of NYPD policies.

But the event didn’t go as planned, thanks to members of the Hallowed Sons Motorcycle Club.

One of the bikers rushed forward in a fit of rage and kicked over the grill, sending embers flying. He then doused it as members of the pro-flag crowd chanted “USA! USA!” The bikers then started trying to rough up the protesters.

Here’s where the ironic part of the story.

…anti-NYPD protesters needed New York’s Finest to save their skin from a gang of angry bikers who tried to pummel them… The protesters were shielded by the cops and escorted out of the park.

And here’s some evidence that silly government regulations (a New York City tradition) take the fun out of protesting and counter-protesting.

While it’s illegal to openly burn anything in Fort Greene Park, the self-styled anarchists managed to find a loophole in the law that allows cooking in closed barbecue grills.

A few final comments on this story.

I realize I shouldn’t care, but I’m always dumbfounded when left-wing crazies refer to themselves as anarchists. Don’t they realize that you can’t be an anarchist while simultaneously advocating for much bigger government?

Reminds me of this bit of humor from the Libertarian Party.

In any event, the supposed anarchists obviously aren’t very bright since they thought it was a good idea to get on the wrong side of a bunch of bikers.

Since this is America’s Independence Day, I can’t help but think they got what they deserved, even though in the abstract I support their right to protest and burn flags that they bought with their own money (or, more likely, with money from their parents or from the welfare office).


Now for today’s main topic.

I appreciate tax havens for many reasons, mostly having to do with the importance of having some sort of external constraint on the tendency of politicians to over-tax and over-spend.

But I also like these low-tax jurisdictions for non-tax reasons. And high on my list is that I want people to have safe havens for their money as an insurance policy against governments that are incompetent, venal, abusive and/or corrupt.

And for the same reason, I like alternative currencies such as bitcoin (click here is you want to see a short and informative primer). These “cryptocurrencies” give people a way of protecting themselves when government mis-manage or mis-use monetary and financial systems.

And we have some very compelling real-world examples of how this works.

We’ll start with Greece, where people with bitcoins still enjoy liquidity. Those using the banking system, by contrast, are in trouble because of irresponsible government policy.

Here are some excerpts from a Reuters story.

There is at least one legal way to get your euros out of Greece these days, to guard against the prospect that they might be devalued into drachmas: convert them into bitcoin. Although absolute figures are hard to come by, Greek interest has surged in the online “cryptocurrency”, which is out of the reach of monetary authorities and can be transferred at the touch of a smartphone screen. New customers depositing at least 50 euros with BTCGreece, the only Greece-based bitcoin exchange, open only to Greeks, rose by 400 percent between May and June, according to its founder Thanos Marinos, who put the number at “a few thousand”. The average deposit quadrupled to around 700 euros.

Why are people shifting to bitcoin?

One part of the answer is that bitcoins are insulated from political risk.

Using bitcoin could allow Greeks to do one of the things that capital controls were put in place this week to prevent: transfer money out of their bank accounts and, if they wish, out of the country. …the bitcoin buyers’ main aim was to shield their money against the prospect that Greece might leave the euro zone and convert all the deposits in Greek banks into a greatly devalued national currency.

And is anyone surprised that there’s interest from other failing welfare states?

Coinbase, one of the world’s biggest bitcoin wallet providers, which is not currently accessible to Greeks, said it had seen huge interest from Italy, Spain and Portugal.

And it’s just a matter of time, I suspect, before there will be interest from France, Belgium, Japan, etc.

Now let’s look at Argentina, another corrupt and dysfunctional government that has a sordid history of abusing both the monetary system and the financial system.

The New York Times in May had an in-depth report on how people in that nation have been using bitcoin to circumvent bad government policy.

His occupation is one of the world’s oldest, but it remains a conspicuous part of modern life in Argentina…to serve local residents who want to trade volatile pesos for more stable and transportable currencies like the dollar. For Castiglione, however, money-changing means converting pesos and dollars into Bitcoin, a virtual currency, and vice versa. …Castiglione joked about the corruption of Argentine politics as he peeled off five $100 bills, which he was trading for a little more than 1.5 Bitcoins, and gave them to his client. …before showing up, he had transferred the Bitcoins — in essence, digital tokens that exist only as entries in a digital ledger — from his Bitcoin address to Castiglione’s.

Why are so many people interested in bitcoin?

Because the government is debasing and manipulating the official currency in ways that indirectly steal from the citizenry.

Had the German client instead sent euros to a bank in Argentina, the musician would have been required to fill out a form to receive payment and, as a result of the country’s currency controls, sacrificed roughly 30 percent of his earnings to change his euros into pesos. Bitcoin makes it easier to move money the other way too. The day before, the owner of a small manufacturing company bought $20,000 worth of Bitcoin from Castiglione in order to get his money to the United States, where he needed to pay a vendor, a transaction far easier and less expensive than moving funds through Argentine banks.

And don’t forget that Argentina’s government is one of the nations with a track record of stealing money when it’s left in banks.

Commerce of this sort has proved useful enough to Argentines that Castiglione has made a living buying and selling Bitcoin for the last year and a half. …The money brought to Argentina using Bitcoin circumvents the onerous government restrictions on receiving money from abroad. …It makes sense that a place like Argentina would be fertile ground for a virtual currency. Inflation is constant: At the end of 2014, for example, the peso was worth 25 percent less than it was at the beginning of the year. And that adversity pales in comparison with past bouts of hyperinflation, defaults on national debts and currency revaluations. Less than half of the population use Argentine banks and credit cards. Even wealthy Argentines fear keeping their money in the country’s banks.

Bitcoin protects consumers from rapacious and feckless politicians.

…in the fall of 2012, when the Argentine government ordered PayPal to bar direct payments between Argentines, part of the government’s effort to slow the exchange of pesos into other currencies. …Argentines were using Bitcoin to circumvent the government’s restrictions. “…competition eliminates all currencies from noneffective governments,” it said… In Argentina, the banks refuse to work with Bitcoin companies like Coinbase, which isn’t surprising, given the government’s tight control over banks. This hasn’t deterred Argentines, long accustomed to changing money outside official channels.

In an ideal world, of course, there would be no need for bitcoin. At least not as a hedge against bad government policy (if a world of private monies, of course, cryptocurrencies presumably would be one of the market-based options).

But we don’t live in an ideal world. Some of us already live in nations where government financial and/or monetary policy make bitcoin a very important alternative.

And others of us live in countries where there is good reason to worry about future instability because of misguided fiscal, monetary, and economic policy. So it will be good if we have options such as bitcoin.

That doesn’t mean, to be sure, that the average person should transfer all their liquid wealth into bitcoin. Indeed, I’ve specifically stated that “I wouldn’t put my (rather inadequate) life savings in bitcoin.

But I certainly want that option if future events warrant a change of strategy.

P.S. If you’re in a patriotic mood (and if you like the Second Amendment), then you’ll definitely enjoy this slideshow.

P.P.S. If you enjoyed the six-frame image about bitcoin owners, you’ll probably like a similar image portraying libertarians.

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The standard argument against an easy-money policy is that it creates distortions in an economy that lead to either rapid increases in the price level, like we endured in the 1970s, or unsustainable asset bubbles, like we experienced last decade.

Those arguments are completely valid, but they only tell part of the story.

Central banks also should be criticized because “quantitative easing” and “zero interest rate policies” create major imbalances in capital markets.

A major new study from Swiss Re quantifies the damage to savers. Here are some excerpts from a CNBC report.

The Federal Reserve’s efforts to stimulate the U.S. economy after the financial crisis ended up costing savers nearly half a trillion dollars in interest income, according to report released Thursday. Since the central bank dropped interest rates to near zero at the end of 2008, savers have labored under plain-vanilla bank accounts and money market funds that have yielded close to nothing. …In a landmark report, Swiss Re quantifies just how much savers and others have languished… The reinsurance firm put the number at $470 billion in the 2008-13 period studied, so the number is likely even higher now. …”the impact of foregone interest income for households and long-term investors has become substantial.” …Swiss Re said the “financial repression” has taken its toll not only on savers but also on some areas of investing.

Here’s a chart from the Swiss Re report. As you can see, an easy-money policy is a massive tool for redistribution, with savers being hurt and government being subsidized.

Indeed, Swiss Re actually calculates a “financial repression index.”

Financial repression reflects the ability of policymakers to direct funds to themselves that would otherwise go elsewhere.

And the level of this repression has been at record highs in recent years.

It is true that some households benefit from easy money and artificially low interest rates. Their debt expenses have been reduced and they also are enjoying higher asset values.

But those benefits may be fleeting if the end result is a bubble that bursts, as happened in 2008.

Writing for the Washington Times, my Cato colleague Richard Rahn agrees that central banks are hurting savers, but he augments this analysis by making the very important point that easy-money policies simply don’t work.

Government economic policymakers have been trying to solve a problem of too much government spending, taxing and regulation by inappropriately using monetary policy, which has not and cannot solve the fundamental problems (it is like using a hammer rather than a shovel to dig a hole). The major central banks have been holding down interest rates, which is actually a massive indirect tax levied on the world’s savers. Historically, savers would receive about 3 percent interest above the rate of inflation on their safest investments, but now interest rates often do not cover even the low inflation that is occurring in the developed countries. …Many economists expected savers to save less and consume more as a result of low or even negative interest rates… When businesses and individuals look at the world debt situation and the increased chances of another financial collapse, their rational response is to increase “precautionary” savings, even though they are not receiving interest on them.

So the bottom line is that central banks are engaging in “financial repression” today and creating risks of price instability and/or asset bubbles tomorrow.

But there’s no compensating benefit to make all these costs (and future risks) worthwhile.

That’s not a good deal.

So what’s the alternative?

In the short run, the best hope is that central bankers, including the ones at the Federal Reserve, will take their feet off the figurative gas pedal and follow some sort of monetary rule that precludes destructive intervention.

In the long run, the ideal answer would be a return to market-provided private currencies. This isn’t just silly libertarian fantasy. There actually have been countries that successfully used this “free banking” approach.

Professor Larry White has a must-read historical review of what happened before governments monopolized currency issue.

When we look into these episodes, we find a record of innovation, improvement, and success at serving money-users. As in other goods and services, competition provided the public with improved products at better prices. The least regulated systems were not only the most competitive but also by and large the least crisis-prone. …the record of these historical free banking systems, “most if not all can be considered as reasonably successful, sometimes quite remarkably so.”…Those systems of plural note issue that were panic prone, like those of pre-1913 United States and pre-1832 England, were not so because of competition but because of legal restrictions that significantly weakened banks. Where free banking was given a reasonable trial, for example in Scotland and Canada, it functioned well for the typical user of money and banking services.

The history of central banking, by contrast, is not nearly as successful. There’s been massive erosion in the value of money and central banks are largely responsible for the boom-bust cycle that has afflicted many economies.

At this point, you may be wondering why central banking triumphed over free banking if the latter is so superior.

The answer is simple. As Professor White explains, look at what’s in the best interest of the political elite.

Free banking often ended because the imposition of heavy legal restrictions or creation of a privileged central bank offered revenue advantages to politically influential interests. The legislature or the Treasury can tap a central bank for cheap credit, or (under a fiat standard) simply have the central bank pay the government’s bills by issuing new money. …Central banks primarily arose, directly or indirectly, from legislation that created privileges to promote the fiscal interests of the state or the rent-seeking interests of privileged bankers, not from market forces.

In other words, a system of competitive currencies is perfectly plausible, but it’s not in the interest of politicians (just as having no income tax is plausible, but also not in the interest of politicians).

For more information on free banking, here’s a video I narrated for the Center for Freedom and Prosperity.

Professor White also has a good video explaining why a central bank isn’t needed.

P.S. For those of you who like the gold standard, Professor George Selgin (now head of Cato’s Center for Monetary and Financial Alternatives) has some major concerns (at least if the government is in charge of it).

P.P.S. Don’t forget that the Federal Reserve also imposes a lot of costly regulation on the financial sector.

P.P.P.S. Thomas Sowell has some wise observations on why we shouldn’t grant more power to the Fed and John Stossel explains why monetary competition would be good.

P.P.P.P.S. To end with some humor, here’s the famous “Ben Bernank” video. And if that doesn’t exhaust your interest in the topic, here’s a snarky cartoon video mocking the Fed and another video with 10 reasons to dislike the Fed.

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During periods of economic weakness, governments often respond with “loose” monetary policy, which generally means that central banks will take actions that increase liquidity and artificially lower interest rates.

I’m not a big fan of this approach.

If an economy is suffering from bad fiscal policy or bad regulatory policy, why expect that an easy-money policy will be effective?

What if politicians use an easy-money policy as an excuse to postpone or avoid structural reforms that are needed to restore growth?

And shouldn’t we worry that an easy-money policy will cause economic damage by triggering systemic price hikes or bubbles?

Defenders of central banks and easy money generally respond to such questions by assuring us that QE-type policies are not a substitute or replacement for other reforms.

And they tell us the downside risk is overstated because central bankers will have the wisdom to soak up excess liquidity at the right time and raise interest rates at the right moment.

I hope they’re right, but my gut instinct is to worry that central bankers are not sufficiently vigilant about the downside risks of easy-money policies.

But not all central bankers. While I was in London last week to give a presentation to the State of the Economy conference, I got to hear a speech by Kristin Forbes, a member of the Bank of England’s Monetary Policy Committee.

She was refreshingly candid about the possible dangers of the easy-money approach, particularly with regards to artificially low interest rates.

Here is one of the charts from her presentation.

Those of us who are old enough to remember the 1970s will be concerned about her first point. And this is important. It would be terrible to let the inflation genie out of the bottle, particularly since there may not be a Ronald Reagan-type leader in the future who will do what’s needed to solve such a mess.

But today I want to focus on her second, fourth, and fifth points.

So here are some of the details from her speech, starting with some analysis of the risk of bubbles.

…when interest rates are low, investors may “search for yield” and shift funds to riskier investments that are expected to earn a higher return – from equity markets to high-yield debt markets to emerging markets. This could drive up prices in these other markets and potentially create “bubbles”. This can not only lead to an inefficient allocation of capital, but leave certain investors with more risk than they appreciate. An adjustment in asset prices can bring about losses that are difficult to manage, especially if investments were supported by higher leverage possible due to low rates. If these losses were widespread across an economy, or affected systemically-important institutions, they could create substantial economic disruption. This tendency to assume greater risk when interest rates are low for a sustained period not only occurs for investors, but also within banks, corporations, and broader credit markets. Studies have shown that during periods of monetary expansion, banks tend to soften lending standards and experience an increase in their assessed “riskiness”. There is evidence that the longer an expansion lasts, the greater these effects. Companies also take advantage of periods of low borrowing costs to increase debt issuance. If this occurs during a period of low default rates – as in the past few years – this can further compress borrowing spreads and lead to levels of debt issuance that may be difficult to support when interest rates normalize. There is a lengthy academic literature showing that low interest rates often foster credit booms, an inefficient allocation of capital, banking collapses, and financial crises. This series of risks to the financial system from a period of low interest rates should be taken seriously and carefully monitored.

Her fourth and fifth points are particularly important since they show she appreciates the Austrian-school insight that bad monetary policy can distort market signals and lead to malinvestment.

Here’s some of what she shared about the fourth point.

…is there a chance that a prolonged period of near-zero interest rates is allowing less efficient companies to survive and curtailing the “creative destruction” that is critical to support productivity growth? Or even within existing, profitable companies – could a prolonged period of low borrowing costs reduce their incentive to carefully assess and evaluate investment projects – leading to a less efficient allocation of capital within companies? …For further evidence on this capital misallocation, one could estimate the rate of “scrappage” during the crisis and the level of capital relative to its optimal, steady-state level. Recent BoE work has found tentative evidence of a “capital overhang”, an excess of capital above that judged optimal given current conditions. Usually any such capital overhang falls quickly during a recession as inefficient factories and plants are shut down and new investment slows. The slower reallocation of capital since the crisis could partly be due to low interest rates.

And here is some of what she said about the fifth point.

A fifth possible cost of low interest rates is that it could shift the sources of demand in ways which make underlying growth less balanced, less resilient, and less sustainable. This could occur through increases in consumption and debt, and decreases in savings and possibly the current account. …if these shifts are too large – or vulnerabilities related to overconsumption, overborrowing, insufficient savings, or large current account deficits continue for too long – they could create economic challenges.

In her speech, Ms. Forbes understandably focused on the current environment and speculated about possible future risks.

But the concerns about easy-money policies are not just theoretical.

Let’s look at some new research from economists at the Federal Reserve Bank of San Francisco, the University of California, and the University of Bonn.

In a study published by the National Bureau of Economic Research, they look at the connections between monetary policy and housing bubbles.

How do monetary and credit conditions affect housing booms and busts? Do low interest rates cause households to lever up on mortgages and bid up house prices, thus increasing the risk of financial crisis? And what, if anything, should central banks do about it? Can policy directed at housing and credit conditions, with monetary or macroprudential tools, lead a central bank astray and dangerously deflect it from single- or dual-mandate goals?

It appears the answer is yes.

This paper analyzes the link between monetary conditions, credit growth, and house prices using data spanning 140 years of modern economic history across 14 advanced economies. …We make three core contributions. First, we discuss long-run trends in mortgage lending, home ownership, and house prices and show that the 20th century has indeed been an era of increasing “bets on the house.” …Second, turning to the cyclical fluctuations of lending and house prices we use novel instrumental variable local projection methods to show that throughout history loose monetary conditions were closely associated with an upsurge in real estate lending and house prices. …Third, we also expose a close link between mortgage credit and house price booms on the one hand, and financial crises on the other. Over the past 140 years of modern macroeconomic history, mortgage booms and house price bubbles have been closely associated with a higher likelihood of a financial crisis. This association is more noticeable in the post-WW2 era, which was marked by the democratization of leverage through housing finance.

So what’s the bottom line?

The long-run historical evidence uncovered in this study clearly suggests that central banks have reasons to worry about the side-effects of loose monetary conditions. During the 20th century, real estate lending became the dominant business model of banks. As a result, the effects that low interest rates have on mortgage borrowing, house prices and ultimately financial instability risks have become considerably stronger. …these historical insights suggest that the potentially destabilizing byproducts of easy money must be taken seriously

In other words, we’re still dealing with some of the fallout of a housing bubble/financial crisis caused in part by the Fed’s easy-money policy last decade.

Yet we have people in Washington who haven’t learned a thing and want to repeat the mistakes that created that mess.

Even though we now have good evidence about the downside risk of easy money and bubbles!

Sort of makes you wonder whether the End-the-Fed people have a good point.

P.S. Central banks also can cause problems because of their regulatory powers.

P.P.S. Just as there are people in Washington who want to double down on failure, there are similar people in Europe who think a more-of-the-same approach is the right cure for the problems caused in part by a some-of-the-same approach.

P.P.P.S. For those interested in monetary policy, the good news is that the Cato Institute recently announced the formation of the Center for Monetary and Financial Alternatives, led by former UGA economics professor George Selgin, which will focus on development of policy recommendations that will create a more free-market monetary system.

P.P.P.P.S. If you watch this video, you’ll see that George doesn’t give the Federal Reserve a very high grade.

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It’s no secret that I’m a huge fan of Ronald Reagan.

He’s definitely the greatest president of my lifetime and, with one possible rival, he was the greatest President of the 20th century.

If his only accomplishment was ending malaise and restoring American prosperity thanks to lower tax rates and other pro-market reforms, he would be a great President.

He also restored America’s national defenses and reoriented foreign policy, both of which led to the collapse of the Soviet Empire, a stupendous achievement that makes Reagan worthy of Mount Rushmore.

But he also has another great achievement, one that doesn’t receive nearly the level of appreciation that it deserves. President Reagan demolished the economic cancer of inflation.

Even Paul Krugman has acknowledged that reining in double-digit inflation was a major positive achievement. Because of his anti-Reagan bias, though, he wants to deny the Gipper any credit.

Robert Samuelson, in a column for the Washington Post, corrects the historical record.

Krugman recently wrote a column arguing that the decline of double-digit inflation in the 1980s was the decade’s big economic event, not the cuts in tax rates usually touted by conservatives. Actually, I agree with Krugman on this. But then he asserted that Ronald Reagan had almost nothing to do with it. That’s historically incorrect. Reagan was crucial. …Krugman’s error is so glaring.

Samuelson first provides the historical context.

For those too young to remember, here’s background. From 1960 to 1980, inflation — the general rise of retail prices — marched relentlessly upward. It went from 1.4 percent in 1960 to 5.9 percent in 1969 to 13.3 percent in 1979. The higher it rose, the more unpopular it became. …Worse, government seemed powerless to defeat it. Presidents deployed complex wage and price controls and guidelines. They didn’t work. The Federal Reserve — custodian of credit policies — veered between easy money and tight money, striving both to subdue inflation and to maintain “full employment” (taken as a 4 percent to 5 percent unemployment rate). It achieved neither. From the late 1960s to the early 1980s, there were four recessions. Inflation became a monster, destabilizing the economy.

The column then explains that there was a dramatic turnaround in the early 1980s, as Fed Chairman Paul Volcker adopted a tight-money policy and inflation was squeezed out of the system much faster than almost anybody thought was possible.

But Krugman wants his readers to think that Reagan played no role in this dramatic and positive development.

Samuelson says this is nonsense. Vanquishing inflation would have been impossible without Reagan’s involvement.

What Reagan provided was political protection. The Fed’s previous failures to stifle inflation reflected its unwillingness to maintain tight-money policies long enough… Successive presidents preferred a different approach: the wage-price policies built on the pleasing (but unrealistic) premise that these could quell inflation without jeopardizing full employment. Reagan rejected this futile path. As the gruesome social costs of Volcker’s policies mounted — the monthly unemployment rate would ultimately rise to a post-World War II high of 10.8 percent — Reagan’s approval ratings plunged. In May 1981, they were at 68 percent; by January 1983, 35 percent. Still, he supported the Fed. …It’s doubtful that any other plausible presidential candidate, Republican or Democrat, would have been so forbearing.

What’s the bottom line?

What Volcker and Reagan accomplished was an economic and political triumph. Economically, ending double-digit inflation set the stage for a quarter-century of near-automatic expansion… Politically, Reagan and Volcker showed that leaders can take actions that, though initially painful and unpopular, served the country’s long-term interests. …There was no explicit bargain between them. They had what I’ve called a “compact of conviction.”

By the way, Krugman then put forth a rather lame response to Samuelson, including the rather amazing claim that “[t]he 1980s were a triumph of Keynesian economics.”

Here’s what Samuelson wrote in a follow-up column debunking Krugman.

As preached and practiced since the 1960s, Keynesian economics promised to stabilize the economy at levels of low inflation and high employment. By the early 1980s, this vision was in tatters, and many economists were fatalistic about controlling high inflation. Maybe it could be contained. It couldn’t be eliminated, because the social costs (high unemployment, lost output) would be too great. …This was a clever rationale for tolerating high inflation, and the Volcker-Reagan monetary onslaught demolished it. High inflation was not an intrinsic condition of wealthy democracies. It was the product of bad economic policies. This was the 1980s’ true lesson, not the contrived triumph of Keynesianism.

If anything, Samuelson is being too kind.

One of the key tenets of Keynesian economics is that there’s a tradeoff between inflation and unemployment (the so-called Phillips Curve).

Yet in the 1970s we had rising inflation and rising unemployment.

While in the 1980s, we had falling inflation and falling unemployment.

But if you’re Paul Krugman and you already have a very long list of mistakes (see here, here, here, here, here, here, here, here, and here for a few examples), then why not go for the gold and try to give Keynes credit for the supply-side boom of the 1980s

P.S. Since today’s topic is Reagan, it’s a good opportunity to share my favorite poll of the past five years.

P.P.S. Here are some great videos of Reagan in action. And here’s one more if you need another Reagan fix.

P.P.P.S. And let’s close with some mildly risqué Reagan humor that was sent to me by a former member of Congress.

Reagan Clinton Joke

If you want more Reagan humor, click here, here, and here.

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