There’s a lot of confusion over my previous post, where I agreed with Jeffrey Hummel’s claim that the Fed has relatively little control over interest rates, at least in the way that most people envision the concept. (Of course they can create high nominal interest rates through persistent inflation, but that’s another issue.)
Let’s return to the road analogy. A bus driver in the Alps can turn the wheel to the left and right, as he wishes. However given the additional constraint that he prefers to avoid a fiery death, he actually has relatively little discretion—for all practical purposes he must follow the road. In contrast, a hippie driving a VW minivan across the Bonneville Salt Flats can wander to the left and right according to his drug-fueled whims. He has true freedom, true discretion.
So let’s go beyond pointless debates over the meaning of “control” and focus on the substantive issue here. I claim that monetary policy is like the bus driver in the Alps, and I also claim that most people, and even many economists, view it as being at least somewhat more like the Bonneville Salt Flats. Use whatever definition of ‘control’ that you prefer, but that is the substantive difference.
I claim that if Bernanke had adopted the sort of interest rate policy advocated by conservatives then we would have gone into a Great Depression, he would have been quickly replaced, and the Fed would have changed course. Just as Trichet was replaced in 2011 after his small interest rate increase pushed the eurozone into a double dip recession (plus debt crisis), and just as Miller was replaced in 1979 when his low interest rate policy pushed the US into double-digit inflation. In both cases their replacement quickly reversed course on interest rates.
Now I may be wrong on these points; some people claim the Fed has little or no control over the economy. In that case they could set rates where ever they wished, and life would go on as usual. I take almost the opposite view. I believe they have very little room to adjust rates without creating a spiral toward hyperinflation or hyperdeflation. Why don’t we see those disasters more often? For the same reason we rarely see buses plunge off 100 foot cliffs–the Fed usually follows the road.
So yes, I understand the Fed controls interest rates in the same sense that a bus driver in the Alps controls steering. To understand what I am trying to say, think about the two driving analogies above. Then think about how conservatives advocated higher interest rates under Bernanke. If you thought that was a plausible policy proposal, then you don’t agree with me on the substantive economic issues. I believe it would have led to disaster, and been quickly reversed. (Again, unless the higher rates were generated by higher inflation expectations, which is not what those conservatives had in mind.)
Off topic, Trump seems to now view the Obama record on jobs as “excellent” not “terrible”. Why the sudden change in the characterization of jobs reports averaging 200,000/month? Could it be because we have a different president?
PS. My wife now spends most of each day on the phone dealing with bureaucracies (government, insurance, banks, etc.) What an annoying Kafkaesque society we’ve created.