The term ‘bond vigilantes’ is a creation credited to Paul Krugman, and it is a somewhat derisive term to represent all of the financial experts and economists who predicted huge increases in interest rates and inflation as a result of the Federal Reserve’s monetary policy and the government fiscal policy. The fact that none of that happened has not dampened the enthusiasm of those so-called experts for their position. Of course, eventually they will be right, just as someone who predicts rain every day for the
will eventually be right.
A Federal Reserve official, Esther George is mightily worried about current Federal Reserve policy.
Esther George, first vice president
of the Federal Reserve Bank of Kansas City
Ms. George told an audience in Kansas City, Mo., Thursday that current Fed policies made her "uneasy" and warned that the Fed "must not ignore the possibility" that monetary policy could contribute to new bubbles that harm the financial system.
Specifically, what is she worried about? Well this
Ms. George noted bond and farmland prices are at very high levels. If there were a big correction in those prices, it could be "destabilizing and cause employment to swing away from its full-employment level and inflation to decline to uncomfortably low levels," she said.
And that is a legitimate worry, except for a couple of things. First is that in order for bond prices to fall interest rates must rise, and the Fed can easily manage a ‘soft landing’ to minimize damages. Furthermore higher interest rates, meaning higher income for savers, investors, pension funds, retired individuals and the like will offset much of any negative impact of the higher rates.
Of course all bets are off if banks and other financial institutions have invested in long term fixed rate assets and at the same time financed those investments with short term borrowing whose costs could rise. This stupidity took place in the late 1970’s and early 1980’s, and surely banks learned that lesson. Didn’t they???