When I first began reading Federal Open Market Committee (FOMC) member Narayana Kocherlakota’s op-ed piece in the Wall Street Journal this morning, I thought that it had to be a deliberate parody on the Keynesian groupthink that characterizes the world’s central bankers. (“Raising Rates Now Would Be a Mistake,” Aug. 19, 2015) Then I realized that Mr. Kocherlakota is dead serious about wanting to continue the Fed’s zero interest rate policy (ZIRP) of the last six years, notwithstanding its failure to bring about anything close to a robust recovery from the 2008 financial collapse.
Mr. Locherlakota says that raising rates now would impede the Fed’s ability to achieve two goals: (1) raise inflation to its 2% target rate, and (2) stimulate spending via credit expansion and bank lending. He fails to explain, however, how either of these goals arises from sound economic thinking. In point of fact, both goals are highly questionable attributes of a growing and productive economy.
As for the first goal, Mr. Kocherlakota merely asserts that 2% inflation is how the Fed defines price stability. No reason is given as to why 2% is superior to any other number, let alone superior to what most people outside of the FOMC would define as a stable price level — zero inflation. In fact, a 2% inflation rate means that the purchasing power of a dollar will decline by almost a third over 20 years. Not only is financial prudence on the part of households severely punished, saving is discouraged and debt-taking encouraged. Diminished saving and increased debt, however, have never been shown to lead to sustained prosperity.
Mr. Kocherlakota’s second goal, increased spending, is similarly misguided. A focus on spending neglects capital accumulation, which is essential to productivity gains and economic growth. Capital accumulation, moreover, requires saving to finance the new capital. Hence, incentivized spending and debt-taking, buttressed by lower saving owing to an inflation tax, must result in a lower rate of capital accumulation and ultimately diminished growth prospects over the long haul.
In the end, price controls never work, and interest rate manipulation will be no exception. Eventually, the massive distortions in asset pricing created by the six-year ZIRP must be corrected. At that time, the tools that the Fed has in its bag will have been seriously depleted, and the correction will likely be long and deep.
Given six years of tepid recovery, it is well past time to jettison the ZIRP and return to free market principles in which interest rates are freely determined in the marketplace by peoples’ time preferences and an honest monetary policy.
2 thoughts on “It Is Well Past Time to End the ZIRP”
Ted, I am glad you questioned this insane policy to raise the rate of inflation to 2%. A weak economy may in fact lead to low aggregate demand and low price pressure. While the low inflation rate might be a symptom of a weak economy, it is not a cause of a weak economy. Proper economic policy making would ask why the economy is weak. Does Mr. Kocherlakota actually believe an inflation rate below 2% causes a low rate of GDP growth?
Great point about low inflation not being a cause of a weak economy, Frank. I wonder what Mr. Kocherlakota would say (??). If you have not already, please also read the previous post re “Janet Yellen and the Power to Tax.” Ted
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