Wednesday, August 17, 2011

Monetary Policy is Not Symmetric – Many Economists Just Don’t Get It

High Interest Rates – Bad, Low Interest Rates – Not Necessarily Good

When the history of The Great Recession, The Technical Recovery, and now what This Dismal Political Economist is calling “The Great Stall” is written, much focus will be on the failure of the economics profession to properly diagnose the cause and to properly prescribe the treatment.

When Monetary Policy is Mostly Ineffective

A large part of this failure will be in the failure to recognize the limits of monetary policy.  Monetary policy can be used to constrain an economy that is growing too fast and producing unacceptable levels of inflation. It can also be used to stimulate an economy that is growing too slow and not producing enough jobs to maintain or lower the level of unemployment.

What many economists do not understand is that the ability of monetary policy to affect an economy that is expanding too fast is far greater than its ability to impact an economy that is growing too slowly.  If the economy is growing at too high a rate, a reduction in credit availability and higher interest rates will slow it down, even stop growth altogether.  Without credit sources, business and consumer spending must slow.

The Shell Game - Monetary Policy

It is naïve and simplistic to assume the opposite is true.  Just because credit is available and interest rates are low does not mean businesses and consumers will spend more, create more demand and increase growth and employment.  A New York Times story nicely illustrates this.

with unemployment high and those with jobs worried about keeping them, consumers are more concerned about paying off the loans they already have than adding more debt.

So why would anyone expect the Federal Reserve policy of keeping rates low to do much for the economy? 

And why can’t they lower rates even more?  Well rates are already about as low as they can physically go.

The credit debacle still hangs over the market.

Lenders, meanwhile, are still dealing with the effects of the boom-gone-bust and are forcing prospective borrowers to go to extraordinary lengths to prove their creditworthiness.

So yes, rates are low, if you can get a loan.

Picture of an Oxymoron

Bobby and Katie Smith have stellar credit, tiny student debt and a combined six-figure income. For part of their down payment, they planned to use about $5,000 they had received as wedding gifts in February.

But the lender would not accept that money unless the Smiths provided a certified letter from each of 14 guests, stating that the money was a gift, rather than a loan

 Yes, the fact that bankers are that stupid does much to explain why they are having problems in the first place. 

All this means that the only bullet left in the gun a Federal policy is fiscal policy, increasing spending to stimulate growth.  And what is the trend in spending ???

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