Home > Uncategorized > Why monetary policies are impotent

Why monetary policies are impotent

from Lars Syll

Even if interest-rate cuts at all points proximately increase demand, there are substantial grounds for concern if this effect is weak. It may be that any short-run demand benefit is offset by the adverse effects of lower rates on subsequent performance …

commercial illustratorFrom a macro perspective, low interest rates promote leverage and asset bubbles by reducing borrowing costs and discount factors, and encouraging investors to reach for yield. Almost every account of the 2008 financial crisis assigns at least some role to the consequences of the very low interest rates that prevailed in the early 2000s. More broadly, students of bubbles, from the economic historian Charles Kindleberger onward, always emphasize the role of easy money and overly ample liquidity.

From a micro perspective, low rates undermine financial intermediaries’ health by reducing their profitability, impede the efficient allocation of capital by enabling even the weakest firms to meet debt-service obligations, and may also inhibit competition by favoring incumbent firms …

In moving toward the secular stagnation view, we have come to agree with the point long stressed by writers in the post-Keynesian (or, perhaps more accurately, original Keynesian) tradition: the role of particular frictions and rigidities in underpinning economic fluctuations should be de-emphasized relative to a more fundamental lack of aggregate demand …

What is needed are admissions of impotence, in order to spur efforts by governments to promote demand through fiscal policies and other means.

Lawrence Summers & Anna Stansbury

New ‘Keynesians’ — like Paul Krugman and Simon Wren-Lewis — have long been arguing that, at the zero lower bound of nominal interest rates, central bankers don’t have the tools to effectively fight recessionary tendencies in the economy. This yours truly and other Post Keynesian economists have criticized, arguing that those monetary measures don’t work even when we’re not even close to the zero lower bound.

In the New ‘Keynesian’ world we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy suffices. The central banks simply adjust the interest rate to achieve full employment without inflation. If governments in that situation take on larger budget deficits, these tend to crowd out private spending and the interest rates get higher.

Now, the logic behind the New ‘Keynesians’ loanable-funds-IS-LM-theory is that if the government is going to pursue an expansionary fiscal policy it will have to borrow money and thereby increase the demand for loanable funds which will — “other things equal” — lead to higher interest rates and less private investment. According to this approach, the interest rate is endogenized by assuming that Central Banks can (try to) adjust it in response to an eventual output gap. This, of course, is essentially nothing but an assumption of Walras’ law being valid and applicable, and that a fortiori the attainment of equilibrium is secured by the Central Banks’ interest rate adjustments. From a Post Keynesian point of view, this is a belief resting on nothing but sheer hope.

We have to free ourselves from the loanable funds theory — and scholastic gibbering about ZLB — and start using good old Keynesian fiscal policies. Keynes — as did Lerner, Kaldor, Kalecki, and Robinson — showed that it was possible to promote economic growth with an “appropriate size of the budget deficit.” The stimulus a well-functioning fiscal policy aimed at full employment may have on investment and productivity does not necessarily have to be offset by higher interest rates.

larryNow Larry Summers has come to realize that the New ‘Keynesian’ dogma is wrong and that we need other stabilisation (read fiscal) tools to get the economy going. That’s great. Now we’re eagerly awaiting some other guys to finely wake up …

  1. postkeynesian spain
    September 5, 2019 at 2:14 am

    “and scholastic gibbering about ZLB ”

    Really Keynes, and the first economist was an scholastic.

  2. Craig
    September 5, 2019 at 4:23 am

    Monetary policy is impotent because it is not direct to the individual via a universal dividend and also is not direct to the individual with a 50% discount to price at the point of retail sale and then reciprocally and fully rebated back to the enterprise by the monetary authority.

    Hunters and Gatherers went from being round and about the land to directly attached to it with agriculture, homesteading and urbanization.

    The Reformation was almost entirely about being coerced into salvation via the sacraments and the powerful recognition that having a direct relationship with god was possible, more personal and more empowering.

    Directness. One of the major aspects of the natural philosophical concept of grace, the key to remedying the dis-empowering abstractionism of science and the acculturation of wisdom.

    Pundits and economists: It’s the monetary, financial and economic paradigm, stupid.

  3. Ken Zimmerman
    September 5, 2019 at 12:28 pm

    In cultural arrangements in which there are no obligations, this might be an interesting discussion. But in the current ‘real world’ of ‘obligation’ societies (including payments, e.g., retirement, social security, public safety, infrastructure, health care), peoples’ lives and ultimately the entire society is disrupted and perhaps ultimately falls apart when the obligations are not met. If there is a recession later this year or early next year, most of the west will be hit very hard. And because of the great economic inequality in those societies, benefits and retirements checks will be cut off, infrastructure will crumble (even below where it is now), health care of most western societies will shut down, police and fire departments will close, etc. In this scenario, I don’t think those whose needs are not being met will accept the justification that there is no money to fulfill these obligations. They know the 1% and 0.01% control huge amounts of wealth and income. They will, if they’re patient elect governments with mandates to confiscate this money to meet societal needs. If they’re not patient, they will take the wealth and income directly. What combination of fiscal and monetary polices will stop these events, or even slow them down? Policies from economists and political “conservatives” have put the west in a vice that’s closing quickly. Fix it, if you can? No dodging, no punting it down the road, no pretending there isn’t any problem.

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