Thursday, December 13, 2012

Fox Business to Federal Reserve: Destroy the Economy, Please!

Well, I'm back from my lengthy hiatus. Sorry about that, real life intervened in the form of final exams and papers and all that. Apparently now I have a degree in economics, or something. Take that for what it's worth, I suppose. In any case, I just finished reading an article on Fox Business in which the author writes about the growing calls by some for the Fed to raise interest rates in order to boost the economy. Yes, you read that right--contractionary monetary policy will benefit the economy right now. Their reasoning is that the current Fed policy of very low interest rates is "punishing savers" and thus is hurting the economy. This is a common criticism of Fed policy right now, and I think it ought to be debunked, because it is misleading at best and downright dangerous at worst.

The article's thesis, such as it is, goes like this:
"The argument holds that interest rates held at a range of 0% and 0.25% for over four years -- and with no end in sight -- combined with open-ended asset buying programs designed specifically to push long-term rates such as mortgages lower are beginning to take their toll on the broader economy by shrinking household incomes such that consumers are being forced to cut back on spending."
I wasn't sure at first what the author even meant in the last part of that, since he provided no reasoning behind why household incomes would shrink because of low interest rates. Then I realized that what he really meant by "household incomes" was that the policy punishes savers:
"Kelly suggested these households would stand to benefit if the Fed started gradually raising interest rates. Higher interest rates would potentially increase their household income, allowing them to spend more, which would ultimately drive up demand for goods, generate jobs and lead to economic growth."
Again, there's not much explanation of precisely how higher interest rates would do any of this. The only inkling of an explanation is that somehow higher interest rates would allow households to get slightly higher returns in their savings accounts and thus have more money to spend. But there are two issues with this seemingly tortured logic: yes, households might get a little more of a return off of a savings account if rates were a few percentage points higher, but businesses would start laying people off if rates were hiked--remember the early 1980s? So that same family that started getting 2% interest paid on their savings account would suddenly find themselves without jobs. Needless to say, their incomes probably wouldn't be higher if that happened.

The other issue with the "punishing savers" line of reasoning is that it doesn't account for what "saving" really is. When people save money, they basically buy up an asset--it could be anything from stock in a company to a plot of suburban land--and they hold on to it in the hopes of selling it later for a profit. If the economy does well over the next several years, say, because of low interest rates at the Fed, your "saving" will also do well--you'll be able to sell a lot of those assets for a profit. Now imagine, if you will, that the hard-money brigade rolls up to the Federal Reserve building in Washington and Ron Paul demands higher interest rates, and rates are raised. Suddenly the economic outlook doesn't look so hot--consumption plummets, general demand in the economy takes a nosedive as firms cut back on hiring and investment, and construction sputters to a halt. What do you think happened to the value of your assets when those rates were raised? That's right, they've gone way down in value. 

Now which of those two policies do you think punishes  the bulk of savers more? The answer, I hope, should be fairly obvious now.