When Zero Rates Don’t Work
Jon Hilsenrath, the Wall Street Journal's ferret at the Fed, reports what the Federal Reserve wants the public to know while retaining anonymity. He found the professors in a stew. In the June 19, 2012, edition, Hilsenrath disclosed: "Fed officials have been frustrated in the past year that low interest rate policies haven't reached enough Americans to spur stronger growth, the way economics textbooks say low rates should. By reducing interest rates-the cost of credit-the Fed encourages household spending, business investment and hiring, in addition to reducing the burden of past debts. But the economy hasn't been working according to script."
Since the professors wrote the textbooks, Fed headquarters is not a source of economic inspiration. Textbooks in the U.S. are the monopoly of Bernanke, Romer, Mishkin and a few other cross-pollinated primates.
Notable in Federal Reserve Chairman Ben Bernanke's Essays on the Great Depression is its inbreeding. The professor is unsparing in his praise of such contemporaries as Romer, Mishkin, and of course, devoted to Friedman and Schwartz. He neglects earlier economists who might have modified the certainty of his negative real interest rate policy.
There were many prominent economists - two, three, and four generations ago - who warned that low- and lower- and zero-percent interest rates may fail to waken an economy. Bank reserves may sit in the bank. That's that.
This happened in the Great One. It was obvious by the mid-1930s there was little appetite for lending or borrowing, even with interest rates below one percent. If ever the phrase "it takes two to tango" fits, here we are. A loan includes two parties: a lender and a borrower. Reading Hilsenrath's article, the stalagmites in the Eccles Building only think about the lack of lending. The possibility that credit-worthy customers do not want to borrow is apparently negligible.
By 1934-1935 the domestic banking system had become saturated with idle cash. So notes David Stockman, former director of the Office of Management and Budget under President Reagan, in the draft of his future book: The Great Deformation: How Crony Capitalism Corrupted Free Markets and Democracy. Stockman writes that excess bank reserves at the Fed rose from $2.7 billion in 1933 to $11.7 billion by 1939. These fallow dollars remained sterile, like Grandpa Joad's farm. They accounted for 75% of the Fed's balance-sheet growth during the period.
Bernanke has entirely ignored earlier scholarship, but it may be of interest to readers:
In 1910, William Beveridge (of the 1942 Beveridge Report) wrote:
In 1926, Dennis Robertson:
Robertson also wrote:
In 1936, Wilhelm Ropke: "The American experiences have amply verified the surmise that even an interest rate which approaches zero may be insufficient...to induce entrepreneurs to enter upon new investment." – Wilhelm Ropke, Crises and Cycles, William Hodge & Company, Limited, 1936
In 1937, C.A. Phillips, T.F. McManus and R.W. Nelson:
Also from the trio:
The reader may note a common theme in the titles to these books, "banking" and "cycles" recurring. This suggests why Bernanke & Co. may remain detached from such tomes. They do not believe in cycles. If bad things happen, the intruders are thwarted by good policy. That the policy is "good" is assumed. (I am not making this up.) In 1937 (probably: this is from the 1946 edition), Gottfried Haberler:
Haberler discussed Ralph Hawtrey, who changed his mind. Hawtrey's shift is mentioned since there is an inverse relationship between one's status (regardless of whether we are discussing economists, biologists, or motor mechanics) and the willingness to admit one's error. Hats off to Hawtrey: