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Posts Tagged ‘Government intervention’

When debating and discussing the 2008 financial crisis, there are two big questions. And the answers to these questions are important because the wrong “narrative” could lead to decades of bad policy (much as a mistaken narrative about the Great Depression enabled bad policy in subsequent decades).

  1. What caused the crisis to occur?
  2. What should policy makers have done?

In a new video for Prager University, Nicole Gelinas of the Manhattan Institute succinctly and effectively provides very valuable information to help answer these questions. Particularly if you want to understand how the government promoted bad behavior by banks and created the conditions for a crisis.

Here are some further thoughts on the issues raised in the video.

Deregulation didn’t cause the financial crisis – Nicole explained that banks got in trouble because of poor incentives created by previous bailouts, not because of supposed deregulation. As she mentioned, their “risk models” were distorted by assumptions that some financial institutions were “too big to fail.”

But that’s only part of the story. It’s also important to recognize that easy-money policies last decade created too much liquidity and that corrupt subsidies and preferences for Fannie Mae and Freddie Mac steered much of that excess liquidity into the housing sector. These policies helped to create the bubble, and many financial institutions became insolvent when that bubble burst.

TARP wasn’t necessary to avert a meltdown – Because the video focused on how the “too big to fail” policy created bad incentives, there wasn’t much attention to the topic of what should have happened once big institutions became insolvent. Defenders of TARP argued that the bailout was necessary to “unfreeze” financial markets and prevent an economic meltdown.

But here’s the key thing to understand. The purpose of TARP was to bail out big financial institutions, which also meant protecting big investors who bought bonds from those institutions. And while TARP did mitigate the panic, it also rewarded bad choices by those big players. As I’ve explained before, using the “FDIC-resolution” approach also would have averted the panic. In short, instead of bailing out shareholders and bondholders, it would have been better to bail out depositors and wind down the insolvent institutions.

Bailouts encourage very bad behavior – There’s a saying that capitalism without bankruptcy is like religion without hell, which is simply a clever way of pointing out that you need both profit and loss in order for people in the economy to have the right set of incentives. Bailouts, however, screw up this incentive structure by allowing private profits while simultaneously socializing the losses. This creates what’s known as moral hazard.

I’ve often used a simple analogy when speaking about government-created moral hazard. How would you respond if I asked you to “invest” by giving me some money for a gambling trip to Las Vegas, but I explained that I would keep the money from all winning bets, while financing all losing bets from your funds? Assuming your IQ is at least room temperature, you would say no. But our federal government, when dealing with the financial sector, has said yes.

Good policy yields short-run pain but long-run gain – In my humble opinion, Nicole’s most valuable insight is when she explained the long-run negative consequences of the bailouts of Continental Illinois in 1984 and Long-Term Capital Management in 1998. There was less short-run pain (i.e., financial instability) because of these bailouts, but the avoidance of short-run pain meant much more long-run pain (i.e., the 2008 crisis).

Indeed, this “short termism” is a pervasive problem in government. Politicians often argue that a good policy is unfeasible because it would cause dislocation to interest groups that have become addicted to subsidies. In some cases, they’re right about short-run costs. A flat tax, for instance, might cause temporary dislocation for some sectors such as housing and employer-provide health insurance. But the long-run gains would be far greater – assuming politicians can be convinced to look past the next election cycle.

Let’s close by re-emphasizing a point I made at the beginning. Narratives matter.

For decades, the left got away with the absurd statement that the Great Depression “proved” that capitalism was unstable and destructive. Fortunately, research in recent decades has helped more and more people realize that this is an upside-down interpretation. Instead, bad government policy caused the depression and then additional bad policy during the New Deal made the depression longer and deeper.

Now we have something similar. Leftists very much want people to think that the financial crisis was a case of capitalism run amok. They’ve had some success with this false narrative. But the good news is that proponents of good policy immediately began explaining the destructive role of bad government policy. And if Nicole’s video is any indication, that effort to prevent a false narrative is continuing.

P.S. The Dodd-Frank bill was a response to the financial crisis, but it almost certainly made matters worse. Here’s what Nicole wrote about that legislation.

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If you’re a libertarian or a small-government conservative, it’s quite likely you believe both these statements.

  1. Instead of picking winners and losers with special preferences and penalties, the tax code should be simple and fair, treating all economic activity similarly.
  2. Anything that reduces revenue to government is a good thing, and it’s especially good if the net result is to improve public safety by expanding gun ownership.

But what happens if these two statements are in conflict?

This isn’t a hypothetical question. As reported by Politico, there’s legislation in Louisiana to have a special three-day “tax holiday” on purchases of selected products, including guns and ammo.

Louisiana’s state legislature decided Tuesday to eliminate a tax holiday for hurricane equipment and school supplies, but keep one for guns and other hunting tools. In a 7-2 vote, the Louisiana Senate’s Committee on Revenue and Fiscal Affairs decided that for a three-day weekend at the beginning of September the state would eliminate its sales tax on firearms, ammunition, knives and ATVs. …Ultimately, three Democrats voted with four of their Republican colleagues to keep the tax holiday for hunting while eliminating the other two.

Is this a good idea?

I’m conflicted. As a fan of the flat tax, I obviously don’t want government to micro-manage the economy with back-door industrial policy in the tax code. And I’ve also written that tax holidays are a less-than-ideal way of reducing taxes. So this suggests that I’m against the Louisiana proposal.

But on the other hand, I’m an advocate of “starve the beast,” which means I support policies that will shrink the amount of revenue controlled by politicians. And I also strongly support the Second Amendment and want safer communities, so I like the idea of expanded gun ownership.

So how would I have vote if (Heaven forbid!) I was a Louisiana legislator?

I guess I would vote yes. Based on the limited information in the article, the proposal is a pure tax cut. So while I don’t like loopholes, I’ve also stated that I only want to eliminate such preferences if all the revenue was used to lower tax rates.

So the bottom line is that I would oppose the policy if the holiday was financed by an increase in the overall sales tax rate (similarly, I would support getting rid of the holiday as part of a proposal to lower the overall sales tax rate). But since such tradeoffs don’t apply, I would grudgingly offer my support (especially since I know the plan would offend anti-gun statists such as Michael Bloomberg).

P.S. We’ll add this post to my collection of libertarian quandaries.

P.P.S. Since we have a gun-related topic, I can’t resist sharing this example of pro-Second Amendment propaganda.

By the way, if you disagree with the message in this image, please take this IQ test for criminals and liberals and reconsider your views.

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When one thinks about all the Obamacare lies, it’s difficult to identify the worst one.

In other words, just about everything we were told was a fib. Even the tiny slivers of good news resulting from Obamacare were based on falsehoods.

So I almost feel like I’m guilty of piling on by writing about another big Obamacare lie.

But Charles Krauthammer has such a strong critique of Obamacare’s mandate for electronic health records that I can’t resist. He starts by pointing out that doctors are unhappy about this costly new mandate.

…there was an undercurrent of deep disappointment, almost demoralization, with what medical practice had become. The complaint was not financial but vocational — an incessant interference with their work, a deep erosion of their autonomy and authority…topped by an electronic health records (EHR) mandate that produces nothing more than “billing and legal documents” — and degraded medicine.

Not just unhappy. Some of them are quitting and most of them are spending less time practicing actual health care.

Virtually every doctor and doctors’ group I speak to cites the same litany, with particular bitterness about the EHR mandate. As another classmate wrote, “The introduction of the electronic medical record into our office has created so much more need for documentation that I can only see about three-quarters of the patients I could before, and has prompted me to seriously consider leaving for the first time.” …think about the extraordinary loss to society — and maybe to you, one day — of driving away 40 years of irreplaceable clinical experience.

Then Krauthammer exposes the deceptions we were fed when Obamacare was being debated.

The newly elected Barack Obama told the nation in 2009 that “it just won’t save billions of dollars” — $77 billion a year, promised the administration — “and thousands of jobs, it will save lives.” He then threw a cool $27 billion at going paperless by 2015. It’s 2015 and what have we achieved? The $27 billion is gone, of course. The $77 billion in savings became a joke. Indeed, reported the Health and Human Services inspector general in 2014, “EHR technology can make it easier to commit fraud,” as in Medicare fraud, the copy-and-paste function allowing the instant filling of vast data fields, facilitating billing inflation.

A boondoggle on the back of taxpayers. Flushing $27 billion is bad enough, but the indirect costs also are large.

That’s just the beginning of the losses. Consider the myriad small practices that, facing ruinous transition costs in equipment, software, training and time, have closed shop, gone bankrupt or been swallowed by some larger entity. …One study in the American Journal of Emergency Medicine found that emergency-room doctors spend 43 percent of their time entering electronic records information, 28 percent with patients. Another study found that family-practice physicians spend on average 48 minutes a day just entering clinical data.

Here’s the bottom line.

EHR is health care’s Solyndra. Many, no doubt, feasted nicely on the $27 billion, but the rest is waste: money squandered, patients neglected, good physicians demoralized.

Not much ambiguity in that sentence. To put it bluntly, “EHR” is the kind of answer you get when you ask a very silly question.

But on a more serious note, now read what Dr. Jeffrey Singer wrote about electronic health records. Simply stated, this is like Solyndra, but much more expensive. Instead of wasting a few hundred million on cronyist handouts to Obama campaign donors, EHR is harming an entire sector of the economy.

The only thing I’ll add is that neither Krauthammer nor Singer contemplated the possible risks of amassing all the information contained in EHRs given the growing problem of hacking and identity theft.

P.S. On another topic, I’ve written several times about the excessive pay and special privileges of bureaucrats in California.

Now, thanks to Reason, we can read with envy about another elitist benefit for that gilded class.

…a little-known California state program designed to protect police and judges from the public disclosure of their home addresses had expanded into a massive database of 1.5 million public employees and their family members… Because of this Confidential Records Program, “Vehicles with protected license plates can run through dozens of intersections controlled by red light cameras and breeze along the 91 toll lanes with impunity,” according to the Orange County Register report. They evade parking citations and even get out of speeding tickets because police officers realize “the drivers are ‘one of their own’ or related to someone who is.”

You may be thinking that the law surely was changed after it was exposed by the media.

And you would be right. But if you thought the law would be changed to cut back on this elitist privilege, you would be wrong.

…the legislature did worse than nothing. It killed a measure to force these plate holders to provide their work addresses for the purpose of citations — and expanded the categories of government workers who qualify for special protections. This session, the legislature has decided to expand that list again, never mind the consequences on local tax revenues, safety and fairness. …Given the overwhelming support from legislators, expect more categories to be added to the Confidential Records Program — and more public employees and their families being free to ignore some laws the rest of us must follow.

This is such a depressing story that I’ll close today with this bit of humor about bureaucracy in the Golden State.

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When I write about columns in the New York Times, I’m normally pointing out silly examples of bias or exposing absurd mistakes (with Paul Krugman deserving his own special category for sloppiness, as seen here, here, here, here, here, herehere, here, here, here, here, and here).

But every so often, there’s an insightful piece that is worth sharing rather than worth mocking. And that’s the case with a column by Claire Cain Miller on the unintended negative consequences of policies that ostensibly are supposed to help women but actually hurt them.

In Chile, a law requires employers to provide working mothers with child care. One result? Women are paid less. In Spain, a policy to give parents of young children the right to work part-time has led to a decline in full-time, stable jobs available to all women — even those who are not mothers. Elsewhere in Europe, generous maternity leaves have meant that women are much less likely than men to become managers or achieve other high-powered positions at work.

Why all these bad results, which seemingly are contrary to the intentions of lawmakers?

…these policies often have unintended consequences. They can end up discouraging employers from hiring women in the first place, because they fear women will leave for long periods or use expensive benefits.

Amen. You don’t make workers more attractive to employers with laws and regulations that increase the real and/or potential costs of employing those workers.

The column cites some research on the impact of the Family and Medical Leave Act in the United States. As well as the harmful effect of similar laws in other nations.

Women are 5 percent more likely to remain employed but 8 percent less likely to get promotions than they were before it became law, according to an unpublished new study by Mallika Thomas, who will be an assistant professor of economics at Cornell University. …These findings are consistent with previous research by Francine Blau and Lawrence Kahn, economists at Cornell. In a study of 22 countries, they found that generous family-friendly policies like long maternity leaves and part-time work protections in Europe made it possible for more women to work — but that they were more likely to be in dead-end jobs and less likely to be managers.

The bottom line is that government intervention is not a recipe for helping people, especially once you factor in the effect of unintended consequences.

Speaking of which, I made the same argument when looking at a government proposal to help those struggling with long-run unemployment.

All of which tells us that you must have asked a very silly question if the answer is more government.

P.S. My favorite articles and columns from the New York Times are the ones that accidentally show the superiority of small government and free markets.

P.P.S. Since I wrote the other day about the wisdom of allowing successful foreigners to emigrate to the United States, here’s a related graphic.

Maybe I’m missing something, but doesn’t this suggest we should welcome more Indians to America?

After all, the economy isn’t a fixed pie and sensible folks understand that the rest of us benefit when there are more rich and successful people.

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I almost feel sorry for my leftist friends. Whenever there’s a story about a crazed shooter, they invariably speculate that it’s someone affiliated with the Tea Party. So they must be sad when it turns out to be a random nut or in some cases a leftist.

Similarly, when the news broke a few days ago about the Amtrak derailment, they instantly decided that the crash was the result of inadequate handouts from Washington. So imagine how forlorn they must be since it turns out the bureaucrat in charge of the train was traveling at about twice the appropriate speed.

But let’s set aside the tender feelings of our statist buddies and look to see whether there are any policy lessons to learn from the recent Amtrak tragedy.

Writing for National Review, Kevin Williamson makes a key point that Amtrak, like other parts of government, is first and foremost focused on maximizing the amount of money that can be extracted from taxpayers.

…everything from the stimulus bill to regular appropriations has spent billions of dollars on Amtrak, and Amtrak still failed to install the speed-control system that was supposed to be completed this year — a system that the NTSB and others believe would have prevented this accident. So, the “investments” in safety systems have produced no safety system. Where does Amtrak spend its money? Almost every dime of ticket revenue is spent on personnel — salaries, benefits, bonuses, etc.  Amtrak can’t be bothered to finish up a safety system on time. But did Amtrak CEO Joseph Boardman ever miss a nickel of his $350,000-a-year salary? No. Did Amtrak fail to pay employee bonuses? No—in fact, it paid bonuses to people who weren’t even eligible for them, and then refused to rescind them once it was pointed out that they were unauthorized. So Amtrak took care of Amtrak’s priorities, just like every other government agency. But Amtrak’s priorities are not its customers’ priorities.

In other words, the culture at Amtrak is to maximize goodies from government, not to maximize profits, which is the culture at a real company.

And the beneficiaries are the overpaid bureaucrats who operate Amtrak, as well as the insiders (like Joe Biden’s son) who get special appointments to Amtrak’s board of directors.

So what, then, is the solution?

As explained by Jeffrey Dorfman, an economics professor at the University of Georgia, it’s time to wean Amtrak from the public teat.

…within two days liberal politicians had seized on the occasion to demand larger subsidies for Amtrak. In fact, the events of last week show the precise opposite-Amtrak should not receive a larger subsidy, but rather should be sold off and privatized. Currently, Amtrak receives more than $1 billion in funding from Congress although it still manages to lose money. …This leads to the question of why Americans taxpayers should subsidize a rail service that only somewhere around one or two percent of Americans actually use. The clear and obvious answer is that they should not be. While Democratic leaders are calling for more federal funding, the problem is not a lack of subsidies but instead that Amtrak’s leadership is divided between serving its customers and serving the political benefactors who provide it with about $1.4 billion per year. If Amtrak was privatized, it could focus solely on serving its customers. If those customers were concerned with safety, then Amtrak would prioritize safety improvements because that would be a necessary step to staying in business.

Moreover, Amtrak would have the incentive to behave rationally if it wasn’t sponging off taxpayers.

If sold for a fairly low valuation for a railroad, Amtrak would sell for around $6.5 to $7 billion. …the federal government would save the $1.4 billion each year that it has been providing to Amtrak. After privatization, Amtrak will know that federal government subsidies are not available to it and will focus on serving its customers and turning a profit. That may mean that some routes are discontinued or continue operating with fewer scheduled trains. At the same time, some routes, such as those in the northeast corridor, may see an increase in the quality and frequency of service as Amtrak responds to the level of consumer demand in the free market.

Notwithstanding the recent accident, trains actually are very safe. And in the absence of government meddling, a private rail company would have the right incentives to produce the correct amount of investments in safety.

Train travel is already ten times safer than driving in terms of deaths per mile traveled. It is possible that riders do not want to pay more for train tickets in exchange for safety improvements. After all, Amtrak is actually ahead of many private railroads in installing the positive train control safety systems. However, if riders demand it, a private, profit-oriented railroad will provide it.

P.S. Here’s a personal story to give you a sense of Amtrak’s misguided culture.

P.P.S. The good news, for what it’s worth, is that Amtrak is a bargain for taxpayers compared to the rail boondoggle taking place in California. And I guess we should be happy that we don’t have the Chinese version of Amtrak.

P.P.P.S. Don’t carry a lot of cash if you’re a young black male and riding Amtrak.

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I don’t know which group is more despicable, Greek politicians or the voters who elected them. In both cases, they think they’re entitled to other people’s money.

But since the “other people” in this case happen to live in nations such as Germany and Finland, and those folks don’t want to write blank checks to a bunch of moochers and looters, Greece faces a difficult choice.

Either the Greeks behave like adults and rein in their bloated public sector. Or they throw a tantrum, which presumably means both a default on payments to bondholders and a return to the unstable drachma currency.

My guess is they’ll eventually go with the latter option.

But maybe there’s hope for Greece. One of the Prime Minister’s chief economic advisers, an out-of-the-closet communist, has announced his resignation. Here are a few of the details from a story in the EU Observer.

Giannis Milios, a member of Syriza’s central committee and long time economic advisor to Greek prime minister Alexis Tsipras, resigned Wednesday… A professor of economic policy who defines himself as a Marxist, Milios is considered one of the most loyal members of the left-wing party.

So does this signal a shift to more mature and sensible policy?

Perhaps not. According to an article in the Wall Street Journal, the problem in Greece isn’t really the communists. It’s the American leftists like Paul Krugman!

Germany, many other governments and senior policy makers in Brussels believe…that recklessness has been encouraged by misguided political and economic philosophies and bad advice from abroad. It isn’t so much that many in Mr. Tsipras’s Syriza party are Marxists—the eurozone can handle followers of the bearded 19th-century German philosopher. It is more that they are seen to be excessively influenced by a 20th-century British economist—John Maynard Keynes—and his living Anglo-Saxon disciples. At finance ministers’ meetings in Brussels, Mr. Varoufakis has been accompanied by American economists James Galbraith and Jeffrey Sachs. From across the Atlantic, the new government gets strong rhetorical backing from Paul Krugman, Joseph Stiglitz and others.

Wow, this is remarkable. Who would have guessed that run-of-the-mill American leftists are more damaging to economic policy than communists!

I guess this is because the Marxists are probably harmless crazies who hang out in coffee houses and gripe about the capitalist class.

The American leftists like Krugman, by contrast, do real damage because they use discredited Keynesian theory to argue that politicians should be spending even more money to “stimulate” an economy that’s in a crisis because of previous bouts of government spending.

Sort of like trying to get out of a hole by digging even deeper.

What’s amazing is that Krugman and other American statists are pushing bad policy when there are successful examples of nations escaping fiscal crisis with genuine spending cuts.

John Dizard wrote an interesting article about Greece for the Financial Times. He began his article by quoting Krugman, who wrote that the plans of the crazy Greek government are “not radical enough.” Dizard also shared another quote from Krugman, which criticized proponents of lower spending because “the best the defenders of orthodoxy can do is point to a couple of small Baltic nations.”

So Dizard decided to compare Greece with those Baltic nations of Estonia, Latvia, and Lithuania.

There are…some practical lessons to learn from…the contrasting ways that Greece has dealt with the world after the global financial crisis compared with the relatively poor Baltic states. Greece took a path of gradual fiscal adjustments weighted towards tax increases, accompanied by a partial debt default. The Baltic states adopted rapid and deep cuts in their state expenditure and current account deficits.

And here’s a shocking bit of news, though it won’t be surprise to folks in the real world. The Baltics have done far better.

The big issue in the Baltic states is upward wage pressure from tight labour markets. That is what we call a high-class problem. This understates the Baltic countries’ achievements. …They also did this without much benefit from concessionary multilateral finance or international debt haircuts.

Dizard looks at some of the differences between the Baltic nations and Greece.

There were virtually no dismissals from the Greek civil service over this period. Salaries were cut, but public sector staffing was reduced with lay-offs of temporary contract workers and early retirements. This had the effect of reducing already low service levels and transferring costs from payrolls to pension obligations. Latvia fired one-third of its civil servants. …The tax burden [in Greece] on salaried workers, compliant domestic businesses and property owners was substantially increased. In contrast, the Baltic states have fairly flat and relatively low tax rates.

All this is music to my ears since I’ve already written about the successful spending cuts in the Baltic countries.

And I particularly enjoyed having the opportunity, back in 2012, to correct the record when Krugman tried to blame Estonia’s 2008 recession on spending cuts that occurred in 2009.

P.S. Since today’s column focused on the statist ideas of Paul Krugman and because he’s a leading voice for the notion that more government spending somehow “stimulates” growth, I can’t resist sharing an explanation of Keynesian economics I gave back in 2009 as part of some remarks to Colorado’s Steamboat Institute.

Feel free to watch the whole video, but fast forward to 3:30 if you’re pressed for time. I’m being snarky, of course, but I also think my debunking of so-called stimulus is spot on.

P.P.S. By the way, the above video is from the Q&A portion of my remarks. If you watch my my actual speech, and if you pay attention about the 1:35 mark, you’ll see I was talking about the importance of having government grow slower than the economy’s productive sector back in 2009 even though I didn’t unveil Mitchell’s Golden Rule until two years later.

P.P.P.S. Since we’re picking on Krugman, here’s something that’s making the rounds on Twitter.

Good ol’ Professor Krugman praised the European approach of bigger government back in 2010, and everything that’s happened since that point has made his assessment look foolish.

Sort of reminds me of the time he attacked me for my gloomy assessment of California and claimed that the Golden State’s job market was strong. But it turns out that California had the 5th-highest unemployment rate in the nation.

P.P.P.P.S. Let’s close with the observation that the mess in Greece shouldn’t be blamed on Krugman. Sure, he’s giving bad advice, but Greek politicians deserve the lion’s share of the blame. Moreover, to the extent that outside advisers get blamed, we should remember that economists like Joseph Stiglitz and Jeffrey Sachs also are involved, and in some cases exercising more influence than Krugman.

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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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