For months we have been subjected to endless discussions of whether the Open Market Committee of the Federal Reserve will or won’t raise short-term interest rates by a trivial amount in September or sometime. Is the palaver of a committee of economists really worth all this media melodrama? You would think people would become bored by it, but apparently they don’t.
Six decades ago, before we got the odd idea that the Federal Reserve has to be led by an economist, William McChesney Martin, who was the Fed Chairman from 1951 to 1970, not an economist, and highly skeptical of economic models, disapprovingly commented, “Instead of making market judgments for themselves, they are chiefly interested in finding out what the Federal Reserve plans to do.” Obviously this has not changed: enormous effort goes into trying to guess what the Fed is going to do, and even more time and effort into talking about it.
This reflects the unfortunate fact that instead of having interest rates depend on market clearing prices, we have established a national price fixing committee for them. Why does anybody think having a national price fixing committee is a good idea? Does anybody think that a particular committee of economists, by getting appointed to positions in the Fed, thereby develops greater insight into the economic and financial future than anybody else? The Fed’s record provides zero evidence for such a belief. It is as poor at economic forecasting as everybody else.
Similarly, do people really believe that the Fed knows what the right level for interest rates is? Why in the world would any thinking person believe this? In the face of the ineluctable uncertainty involved, not only does the Fed not know this, but it cannot know it.
Macroeconomics and the related interest rate manipulation (which operates under the brand name of “monetary policy”), are matters of highly debatable, conflicting theories, not of knowledge. That is why economists can never agree. The Fed sometimes claims its decisions will be “data driven,” but what data means is always debatable. Even the economic past can’t be settled: economists still debate how to understand the Great Depression of eighty years ago.
Reflecting the fundamental uncertainty it always faces, the theories and ideologies of the Fed keep changing over time. The current Fed is committed to the goal of perpetual inflation–2% inflation forever–which it made up and with a straight face keeps trying to convince us is “price stability.” The current Fed is also deeply committed to the remarkably extended period of negative real interest rates it has created, which is crushing savers in order to benefit borrowers and leveraged investors.
Negative interest rates from time to time are not unusual, but to enforce them for years on end is highly so and highly distortive. Suppose the Fed does raise interest rates by ¼% not only this month, but every quarter for a year. Real short-term interest rates will still be negative and still not normal.
In the wake of the financial crisis which ended in 2009, the Fed set out to promote increases asset prices. That was six years ago. It is still at it, and has greatly succeeded, for better or, more likely in the end, for worse. We all know how unpleasant asset price inflations are when they deflate.
Macroeconomics is not a science and suffers from many unintended and unexpected consequences. The Fed cannot be sure of what the results of its current theories and its remarkable forays into uncharted territory will be. It cannot know what the right level of interest rates is. It cannot be sure of what the results of its own actions will be. No wonder it engages in the melodrama which continues to keep our financial journalists so busy.
But it all reflects the underlying mistaken belief that we should have a national price fixing committee in the first place.
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