The Corner

The Fed Should Exit Its Low-Rate Policy

Over at Freakonomics, Raghuram Rajan, a University of Chicago professor and former chief economist of the IMF, has an interesting post on why he thinks the Fed should exit its ultra-low-interest-rate policy sooner rather than later (whether the New York Times’s Paul Krugman likes it or not).

His starts by saying that he is looking for solutions that would allow us to “get out of this recession in a way that is sustainable and does not merely pump up growth in the short term only to see it collapse later.” He gives this analogy:

Since the problem [according to Keynesian economists] is one of driving up demand, any subsidy applied to a general input should work. So following the Keynesian/Krugman model, why not subsidize energy — for example, cut oil, gas and coal prices substantially and keep them low “for an extended period”? Corporations will see their energy bills cut substantially and see profits rise, so they can employ more people. Unemployment will come down, and we will move out of recession. Eventually, we can withdraw the subsidy when the economy is healthier. The benefits are clear. We will get out of the recession and put many unfortunate people back to work. And the sooner we put people back to work, the less long-term damage is done to their employability. So why not do it now?

Because this solution is not sustainable in the long term: The cost is exorbitant, and the short-term and long-term distortions would be devastating. He continues by saying that, identically to this example,

cutting rates is not without cost. But what about the benefits? Are they as large as the Keynesians state them to be?

The real problem is that corporations are not hiring quickly. But corporations did not hire quickly following the recession of 2001 (or that of 1990-91), and the sustained monetary stimulus that many economists supported then led, in no small part, to the housing boom and bust. It did not, however, lead to an explosion in corporate investment. Before saying the real problem is that we are not providing enough monetary stimulus, should we not worry about why corporations didn’t invest then and what other problems will emerge as we keep rates ultra-low while hoping corporations will see the light? I am not arguing that ultra-low interest rates will have no effect on investment, only that I am not convinced the effect (relative to merely low interest rates) is huge, and recent history bears me out.

The whole thing is worth reading.

Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

Most Popular

Politics & Policy

The Omnibus Disgrace

The omnibus spending bill was crafted in secret and will be passed under pressure; raises discretionary spending as the national debt grows; and fails to deliver on any major GOP priorities except increased defense spending. What might turn out to be the signature achievement of unified Republican government this ... Read More

Thursday Links

It's William Shatner's birthday: Here he is in 1978 'singing' Rocket Man, plus a Star Trek/Monty Python mashup. Sold: Isaac Newton’s Notes on the Philosopher’s Stone. It was a long time before anyone admitted that he was interested in alchemy. High-tech forgery: Computer-generated 'Rembrandt' ... Read More
Film & TV

Superannuated ‘Idol’

In the pilot episode of Fox’s American Idol, Simon Cowell defined the show’s thesis: “We are going to tell people who cannot sing and have no talent that they have no talent. And that never makes you popular.” The show’s producers and its three judges -- Cowell, Paula Abdul, and Randy Jackson -- kept ... Read More