Saturday, August 27, 2011

Thomas Hoenig and the Ever-Expanding Universe of Excuses for High Interest Rates

It’s now a week old—an internet lifetime—but we shouldn’t let this pass without comment.  In an interview with Gretchen Morgenson, departing Fed district president Thomas Hoenig offers this bizarre justification for his votes against near-zero interest rates since the 2007 collapse:
We as a nation have consumed more than we produced now for well over a decade. Having very low rates for an extended period of time encourages us to continue focusing on consumption, but to correct our imbalances, we have to focus on production.
Global imbalances made me do it!  Think for a moment, however, and the argument makes no sense at all.

Low interest rates encourage borrowing of all kinds, for production as well as consumption.  All the current export-oriented economies—Germany, China, and before them Japan and Korea—achieved their miracles in low interest rate environments.  The thing is, they had cultures, institutions and policies that steered credit toward producers and away from consumers.  In recent decades the US has had none of the above, and a loss of export capacity and competitiveness has been the result, even though the corporate sector is awash with liquidity.

High interest rates, on the other hand, choke off consumption, but they also discourage investment, and deficient demand is hardly a spur to the creation of new capacity.  There is no theoretical or empirical basis for Hoenig’s argument; it reflects badly on him and the normally shrewd Morgenson should have picked up on it.

To be charitable, however, Hoenig’s fantasies are no more implausible than those of many other inflation-hawks.  We hear claims that inflation reaches an ominous tipping point at 3% or so, after which it is nearly irreversible.  Or that big shifts in the velocity of money are simply a mirage, and central bank injections have to be reflected in price increases, ever and always.  Or the ultimate whopper, peddled shamelessly to the masses, that inflation represents a decline in purchasing power, an assault on the poor, defenseless consumer, even though this is contradicted by the simple logic of the circular flow.

The fact is, there will always be a market for high and low arguments in support of tight money and excess inflation hawkery.  From a social point of view, inflation can be either too low or too high, but from the perspective of creditors the risk is always on the too-high side.  Thus arguments have to be crafted, out of thin air if necessary, to justify putting the war against inflation ahead of all other social objectives.  Hoenig, no matter how absurd his pronouncements, will always be more accepted in the higher circles of finance than apostates like Blanchard and Stiglitz, who look at inflation rationally, in the context of broader economic policy.


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