A guest post by Benjamin Cole
That tight money is sacred is an axiom of right-wing politics today.
The second and related axiom is that monetary policy is currently, and always, too loose.
The third derivative axiom is that low interest rates turn otherwise gimlet-eyed private-sector investors and corporate chieftains into wanton bubble-chasers.
There is a confounding problem with this trifecta of potential central bank sins: As Milton Friedman said, low interest rates are the result of tight money. You can’t get down into the low single digits by printing a lot of money. And you can’t get to zero lower bound and zero inflation without some monetary asphyxiation.
So, if a central bank runs tight money long enough, it will get to…yes, the evil of low interest rates, those low single-digit vigorish IOUs that drive business decision-makers bananas.
Thus, the great good of tight money begets the great evil of low interest rates.
The Paradoxical Oddity
Paradoxically enough, if the U.S. Federal Reserve really wants higher nominal and real interest rates, they will have to loosen, and for a long time. Fed Chief Janet Yellen would have to run an aggressive QE program for a few more years, over the increasingly hysterical objections of the monomaniacal inflation-phobiacs on the FOMC board.
Not likely, eh?
If lenders and bond-buyers came to fear erratic or higher rates of inflation, they would charge an inflation-fear premium. Then the righty-tighties could embrace higher nominal and real interest rates. And if demand for capital was strong enough—thanks to robust economic growth—there might actually be the rationing of credit by price, meaning higher interest rates.
But the preceding scenario is, I am sad to say, mostly fantasy. As it stands now, interest rates might actually go lower. How?
Long-term inflationary expectations—as in 10 years out—are under 2 percent, according to the Cleveland Fed. Not only that, there is a global glut of capital—see the recent Bain & Co. report, A World Awash in Money. The International Monetary Fund’s 2014 report is the obverse of the Bain study; the IMF says we will see weak demand for capital and thus low interest rates for a long time.
So, add a savings glut to dead inflation fears and weak demand for capital and you get…low nominal and real interest rates. Going lower? Maybe. That is the reality in Europe and the risk in the United States.
Musing About Unresolved Problems
Still, I am not sure even an aggressive, expansionist Fed could bring higher nominal and real rates, or even much inflation, although we might have live through years of prosperity to find out.
The unresolved problem is 50-percent savings rates in China; high savings rates in Japan; gigantic and growing sovereign wealth funds; private and public pension plans the world over obligated to build assets; insurance companies under requirements to build balances to match liabilities and a new global upper class able to save. Russian klepto-crats, Chinese cronyists and Mideast oil moguls assemble towers of capital, regardless of interest rates.
The amount of demand for capital it would take to raise interest rates may not be possible. The market may be sending a signal that capital is abundant, and get used to it. This is the new normal.
And inflation? Well, the supply-side in the United States has gone global. In the old days we thought boosting demand through monetary expansion would first bring on new supply, then higher prices, as sellers rationed supply by price. Now, when there is a boost in demand in the United States, global suppliers of goods, services and capital are at the ready and pour in.
How does price allocate a glut of goods, services and capital?
To get to higher interest rates and inflation, we may have to endure years and years of prosperity. And even that may not work. I think we should try anyway.
PS: Just so my right-wing friends know—the left-wing solutions of higher taxes, bigger deficits and more social welfare are awful also…