Fed up with the Fed (and macro and central banking and…)

Prof Joseph Stiglitz has a piece on being Fed with up Fed. He is in the camp that Fed should not increase rates. It is too soon given the global volatility and uncertain trajectory of world economy:

The Fed has a dual mandate – to promote full employment and price stability. It has been more than successful at the second, partly because it has been less than successful at the first. So why will policymakers be considering an interest-rate hike at the Fed’s September meeting?

The usual argument for raising interest rates is to dampen an overheating economy in which inflationary pressures have become too high. That is obviously not the case now. Indeed, given wage stagnation and the strong dollar, inflation is well below the Fed’s own 2% target, not to mention the 4% rate for which many economists (including the International Monetary Fund’s former chief economist, Olivier Blanchard) have argued.

Inflation hawks argue that the inflation dragon must be slayed before one sees the whites of its eyes: Fail to act now and it will burn you in a year or two. But, in the current circumstances, higher inflation would be good for the economy. There is essentially no risk that the economy would overheat so quickly that the Fed could not intervene in time to prevent excessive inflation. Whatever the unemployment rate at which inflationary pressures become significant – a key question for policymakers – we know that it is far lower than the rate today.

If the Fed focuses excessively on inflation, it worsens inequality, which in turn worsens overall economic performance. Wages falter during recessions; if the Fed then raises interest rates every time there is a sign of wage growth, workers’ share will be ratcheted down – never recovering what was lost in the downturn.

The argument for raising interest rates focuses not on the wellbeing of workers, but that of the financiers. The worry is that in a low-interest-rate environment, investors’ irrational “search for yield” fuels financial-sector distortions. In a well-functioning economy, one would have expected the low cost of capital to be the basis of healthy growth. In the US, workers are being asked to sacrifice their livelihoods and wellbeing to protect well-heeled financiers from the consequences of their own recklessness.

The Fed should simultaneously stimulate the economy and tame the financial markets. Good regulation means more than just preventing the banking sector from harming the rest of us (though the Fed didn’t do a very good job of that before the crisis). It also means adopting and enforcing rules that restrict the flow of funds into speculation and encourage the financial sector to play the constructive role in our economy that it should, by providing capital to establish new firms and enable successful companies to expand.

I often feel a great deal of sympathy for Fed officials, because they must make close calls in an environment of considerable uncertainty. But the call right now is not a close one. On the contrary, it is as close to a no-brainer as such decisions can be: Now is not the time to tighten credit and slow down the economy.

The problem is much deeper. Our over reliance on central banks and central banks also showing how important they are, have led to all kinds of issues. It is actually a case of fed up with central banking. Barring a few central banks (just two actually – Bundesbank and Swiss National bank), role of most has been below par. Even for the two, Austrian school economists say that Bundesbank was just partly better. It created lower inflation than the rest but money lost its value even in West Germany. The sort of expectations central banks have raised over the years has led to all this downfall and given us a more realistic picture. Despite seeing all this, our belief in them only keeps growing. The hype over rate cuts and rate increases is only rising with time.


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