Ben Bernanke succeeded Alan Greenspan as chairman of the United States Federal Reserve, February 1, 2006. Two short years later, the housing bubble exploded and America took to the bread lines, the apple carts, and the dust bowls. Which was just fine for Bernanke, who’d always been fascinated by the economic and political causes of the Great Depression of the 1930s, about which he has published numerous academic journal articles.
Now, almost a year out of office, Bernanke wants to get close to the people again, so he started a blog. He figured, he’s already a Distinguished Fellow in Residence with the Economic Studies Program at the Brookings Institution, so why not blog there? So he did.
On Tuesday, Ben posted his first blogpost (that’s so 2006, isn’t it?), titled: “Why are interest rates so low?”
Of course, we all know the answer: interest rates are set not by the market place, or by nature, or by an alien culture that visits Earth every 1, 000 years to reset the button. Interest rates are set by the United States Federal Reserve. If they want them to be, say, 5 percent, why, they sell money to the banks at about 5 percent. If they wanted it to be, say, 17 percent, like they did in the 1970s, just to see what happens — they set it at 17 percent and watched Americans going crazy, losing all faith in their monetary system. OK, so that was a bad idea.
Here’s a good idea: if the U.S. owes the Chinese a couple trillion dollars, why not make interest rates go down to almost zero, so that the U.S. can borrow and give the Chinese money that cost it nothing?
Are we having fun yet?
In his virgin blogpost, Bernanke argues against the eloquent paragraphs I jotted above.
“The Fed does, of course, set the benchmark nominal short-term interest rate, ” Bernanke admits. “The Fed’s policies are also the primary determinant of inflation and inflation expectations over the longer term, and inflation trends affect interest rates, as the figure above shows.”
Except, he continues, “what matters most for the economy is the real, or inflation-adjusted, interest rate (the market, or nominal, interest rate minus the inflation rate).”
He explains: “The real interest rate is most relevant for capital investment decisions, for example. The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.”
That’s true. But then, why do the Fed chairmen keep on messing with the economy, disregarding the lives and fortunes of millions?
In January 2001, then Fed chairman Alan Greenspan, in support of President Bush’s proposed tax decrease, stated that the federal surplus could accommodate a significant tax cut while paying down the national debt.
He actually told Congress it was a bad idea for the U.S. government not to be in debt.
And then Barbara Bush’s less bright kid went ahead and cut taxes and went into a $10 trillion war we never paid for, and everybody started living underground and scavenging for leftovers in the dumpster behind Alfredo’s spaghetti joint.
To understand why it isn’t the Fed doing all this, Bernanke introduces the concept of the “equilibrium real interest rate.”
“The equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment, ” he explains.
“In a rapidly growing, dynamic economy, we would expect the equilibrium interest rate to be high, all else equal, reflecting the high prospective return on capital investments. In a slowly growing or recessionary economy, the equilibrium real rate is likely to be low, since investment opportunities are limited and relatively unprofitable.”
So, Ben, what’s the equilibrium interest rate in an economy that’s blossoming better than ever in the history of the world, while most Americans are near the poverty line, working three jobs to pay the rent and put food on the table? Is it high like in a successful economy, or depressed, like the life of a guy slinging burgers at McDonald’s earning the minimum wage?
“When I was chairman, more than one legislator accused me and my colleagues on the Fed’s policy-setting Federal Open Market Committee of ‘throwing seniors under the bus’ (to use the words of one senator) by keeping interest rates low, ” Bernanke blogs, explaining: “The legislators were concerned about retirees living off their savings and able to obtain only very low rates of return on those savings.”
He continues: “I was concerned about those seniors as well. But if the goal was for retirees to enjoy sustainably higher real returns, then the Fed’s raising interest rates prematurely would have been exactly the wrong thing to do. In the weak (but recovering) economy of the past few years, all indications are that the equilibrium real interest rate has been exceptionally low, probably negative. A premature increase in interest rates engineered by the Fed would therefore have likely led after a short time to an economic slowdown and, consequently, lower returns on capital investments.”
So where should the Fed’s interest rates be?
Ben’s answer is that the Fed should continue doing exactly what they’re doing, because it works for that equilibrium thing.
Yes, I know, breathtaking.
I recommend Pater Tenebrarum’s response to Ben’s first blog, titled “Ben Bernanke’s Apologia for the Fed, ” where he tears apart the former chairman’s arguments the way a real economist should.
Bernanke promises to be back soon, with another explanation about why it’s good for the Fed to keep our money cheap, even as a couple hundred Americans each make in one hour more than the rest of us earn in a lifetime.
Hey, with low interest rates the price of those fancy cat food cans stays down — that should be a boost to those seniors under the bus.