Wednesday, April 1, 2015

Bernanke goes Natural






















"Hey bro, betcha I can chug this between 0.00 and 0.25 seconds!"

We hear the word 'natural' all the time in our busy modern lives: natural remedy, natural ingredients, all-natural, natural grains, etc. However, as any savvy shopper and/or reader of Consumer Reports knows, the word "natural" has no meaning when applied to consumer products. There is no one industry or governmental definition or standard of what consists of "natural", so corporations can, and do, freely slap the "natural" label on just about anything they want.

However, this blog post isn't going to be about lying advertisements, because I don't have the rest of the decade to sit at this computer. No, this post is about the annoying tendency of economists to use the word "natural" in their field of study, even though it almost never applies. Economics is a study of human systems; systems that have been deliberately contrived in some way or another by human activity. Nothing about economic systems are natural, since both property rights and currency, the two building blocks of any "market" system, always have a governmental orgin. The structure, distribution, and quantity of property rights and currency are dependent on government policy, and by proxy, the people who hang around the halls of power when these policies are made.


So it was with slight annoyance/great frustration/indignant fury/neurotic hysteria that I read this recent blog post by former Federal Reserve Chair Ben Bernanke. It seems Bernanke is the latest of the Bearded Jewish Economists (BJE) to join the blogosphere (welcome Ben!), but unfortunately he got off to a bad start. In his very first day of blogging, he decided to dive into the topic of what the "natural" rate of interest is, and the economic theories that compete to decide what this "natural" rate is. No amount of verbal contortions could get Bernanke around the fact that there is simply no such thing as a "natural" rate of interest on currency, for the simple reason that currency itself is not natural. US Dollars don't fall out of the sky or grow on trees, nor did they ever shoot out of the end of Moses' staff. Currencies are simply the products of the entities that issue them, governmental or not. As long as the issuer of said currency does not promise to convert that currency, on demand at some fixed rate, into something else, than that currency has no natural "own" rate, aka interest rate.

Just like the letters in this sentence, US dollars cost nothing to produce. They are merely typed into existence by government employees. Therefore, they carry no "natural" rate of interest or growth, any more than the letters in this sentence can naturally grow. When I come back and re-read this blog post in 6 months, it will have the same amount of letters in it (unles i mak sum editts, off cours). This also happens to be the case with my savings account-- barring any deposits/withdrawals, the balance in my savings account will have the same amount of dollars in it in 6 months, because the rate of interest paid on that account is so low that it only amounts to a few dozen cents per year. This is not because the "natural" rate of interest on my savings account has changed, or there is something unusual about Wells Fargo Account #2248-955118-89! (not my real account number). This is simply because the Federal Reserve, you know, that organization that Mr. Bernanke used to be the head of, has decided that current interest rates should be next to zero. And while I happen to like this zero rate policy (because I believe that no one is entitled to earn any particular rate of interest on federally insured bank deposits that just sit around doing nothing), I don't pretend that it is in any way "natural."

This near zero rate is not any more or less natural than if it was, say 18%, as it was during the Paul Volcker days. Although Volcker raised rates this high in order to destroy labor unions, the middle class, America, etc. nobody claimed that they were "unnatural." The rate in 1982, as it is now, was just A POLICY CHOICE MADE BY OLD WHITE GUYS. It wasn't delivered to them by Jesus. The men and women (ok, mostly men) on the FOMC just pick a number for the overnight interest rate and tell the New York Fed to fiddle around on their computers until that becomes the rate. The only thing natural about this process is that old white men are always in charge (kidding). If the government wants the interest rate on its own liabilities (US dollars) to be zero, than it can be zero; if it wants the rate to be 40%, it can be 40%.  Neither rate is natural.

Going a little deeper, the Wicksellian Monetarists, of which Bernanke appears to be one, believe that at any one time there is a "natural" rate of interest that will lead to full employment. A few of the obvious problems with this Wicksellian or IS/LM theory are that-

1) it was devised under a gold standard economic system which was completely different and no longer exists

2) no one can seem to agree what full employment really is

3) what employment metric do you even use to define "full"

4) We now live in a world with fiat currencies, and computers, and global trade, and robots, and a global labor force, and highly interconnected banking systems, and, and, and.....

One sentence of his blog really set me off, however. According to BB,

"Government spending and taxation policies also affect the equilibrium real rate: Large deficits will tend to increase the equilibrium real rate (again, all else equal), because government borrowing diverts savings away from private investment."

Really Ben? Does your entire career in economics not indicate to you that this isnt the case? If anything, the trend lines during your ENTIRE economic career would indicate THE OPPOSITE:


Thankfully, Mr. Bernanke did get some things right, like saying that the Fed has no choice but to set SOME short term interest rate. However, as far as I can tell, he didnt take the next step and assert that the Fed's short term rate influences the entire yield curve of both paper and capital markets (the latter less directly):


And that's just the effect of the federal funds rate changing. What Bernanke doesnt say is that the Fed can (and has, in the Eccles era) target any point along the yield curve it wishes. It can announce price targets and buy/sell till that target is hit, or simply offer its own long-term term deposits at some rate. For example, if the Fed wanted to set the floor for 30-year mortgages at 8%, it could offer 30-year term deposits at 8%, ensuring no 30-yr mortgage would ever be issued at less than 8%.

So if your forehead has not yet connected with your desk, you are now better at macroeconomics than most of 'em. Now go have yourself a cool, crisp, refreshing can of Natural Light*.



*disclaimer: It is none of these things**

**things includes "beer"

9 comments:

Matt Franko said...

"Gross rips 'hostile, artificially priced' market"

http://finance.yahoo.com/news/bill-gross-everythings-artificially-priced-153854551.html

We dont want 'artifcial' we want 'natural'! ;)

Looks like you've identified a trend here Justin... nice post! rsp,

mike norman said...

Hahahaha. Love this!!!

Critical Tinkerer said...

But Ben is accepting that fiscal policy rules over monetary policy. And also in his testaments to Congress he was also asking for fiscal stimulus while he promissed to keep interest low for public debt. It fell on deaf ears.

I demolished his arguments in his first post about effectivnes of monetary policy bellow 3% because banks do not offer credits bellow 4% interest and monetary policy can go down to -20% but banks will not go bellow 4% no matter what.
CB can make rates negative but banks will not follow. Official rate does not work if banks do not follow and offer it to borrowers.

But he did not dare to post my comments on why monetary policy can not work bellow 3% but he responded in 2. part:

"(I concede that there are some counterarguments to this point; for example, because of credit risk or uncertainty, firms and households may have to pay positive interest rates to borrow even if the real return to safe assets is negative. Also, Eggertson and Mehrotra (2014) offers a model for how credit constraints can lead to persistent negative returns. Whether these counterarguments are quantitatively plausible remains to be seen.)"

But then continued as if he never wrote that. He completly forgot about importance for borrowers to have negative real rates or they will not botrrow.
He forgot how important part of banks existance is to make negative real rates for borrowers and positive real rates for lenders at the same time possible.

I warned him again but he does not want to post my comments.

Critical Tinkerer said...

And Larry Summers responded to his first part post which is much more hillarious then Ben's posts.

Matt Franko said...

No way Jure bb scolds Congress about the "long term debt problems" and never recommended fiscal ... so does Jamie Dimon...

MortgageAngel said...

LOL Great post, Gatekeeper! btw, Ben - Why have a 'blog' if you don't want readers to comment? Seems peculiar. Dare I say 'unnatural'?

Peter Pan said...

Since when is vanity unnatural?

Anonymous said...

Geenspan told Ryan that the debt was bs, but then he climbed on board with the debt apologists and yada yada yada.

I can't figure out whether the truth isn't politically useful or politics has no use for the truth.

At least so far it seems to be schlock-schmoe consistent.

Ralph Musgrave said...

Bernanke right and Gatekeeper wrong. I take the "natural rate of interest" to be the rate at which non currency issuing entities lend to each other for near risk free loans, assuming the currency issuer does not try to influence that rate of interest. (Obviously risky loans cost more).