EMAIL DETAILS

> I agree with Stiglitz but unforetunately the public has become
> fearful for the wrong reason.
>
>
>
> It is folly to place all our trust in the Fed
> By Joseph Stiglitz
> Published: October 18 2010 23:37 | Last updated: October 18 2010 23:37
> In certain circles, it has become fashionable to argue that monetary
> policy is a superior instrument to fiscal policy – more predictable,
> faster, without the adverse long-term consequences brought on by
> greater indebtedness. Indeed, some advocates wax so enthusiastic
> that they support recent drives for austerity in many European
> countries, arguing that if there are untoward effects they can be
> undone by monetary policy. Whatever the merits of this position in
> general, it is nonsense in current economic circumstances.
>
> A quarter-century ago proponents of monetary policy argued, with
> equal fervour, in favour of monetarism: the most reliable
> intervention in the economy was to maintain a steady rate of growth
> in the money supply. Few would hold that now, as the velocity of
> circulation turned out to be less constant than the monetarists
> anticipated. Countries seduced by apparent certainties of monetarism
> found themselves in a highly uncertain world.
>
> EDITOR’S CHOICE
> Global Insight: Fed bets bottom dollar on easing - Oct-17
>
> Bernanke hints at further stimulus - Oct-15
>
> QE2 poised to heighten Asian currency dilemma - Oct-14
>
> Soaring US trade deficit fuels tension - Oct-14
>
> Opinion: Fed feels compelled to experiment - Oct-13
>
> Fed’s hints at easing boost equities - Oct-13
>
> Traditionally, monetary authorities focus policy around setting the
> short-term government interest rate. But, leaving aside the fact
> that with interest rates near zero there is little room for
> manoeuvre, the impact on the real economy of changes in the interest
> rate remains highly uncertain. The fundamental reason should be
> obvious: what matters for most companies (or consumers) is not the
> nominal interest rate but the availability of funds and the terms
> that borrowers have to pay. Those variables are not determined by
> the central bank. The US Federal Reserve may make funds available to
> banks at close to zero interest rates, but if the banks make those
> funds available to small and medium-sized enterprises at all, it is
> at a much higher rate.
>
> Indeed, in the last US recession, the Fed’s lowering interest rates
> did stimulate the economy, but in a way that was disastrous in the
> long term. Companies did not respond to low rates by increasing
> investment. Monetary policy (accompanied by inadequate regulation)
> stimulated the economy largely by inflating a housing bubble, which
> fuelled a consumption boom.
>
> It should be obvious that monetary policy has not worked to get the
> economy out of its current doldrums. The best that can be said is
> that it prevented matters from getting worse. So monetary
> authorities have turned to quantitative easing. Even most advocates
> of monetary policy agree the impact of this is uncertain. What they
> seldom note, though, are the potential long-term costs. The Fed has
> bought more than a trillion dollars of mortgages and long-term
> bonds, the value of which will fall when the economy recovers –
> precisely the reason why no one in the private sector is interested.
> The government may pretend that it has not experienced a capital
> loss because, unlike banks, it does not have to use mark-to-market
> accounting. But no one should be fooled.
>
> By contrast, if we extend unemployment benefits we know, not
> perfectly but with some degree of precision, how much of that money
> will be spent. Doubters of the effectiveness of fiscal policy worry
> that such spending will simply crowd out other spending, as
> government borrowing forces interest rates up. There may be times
> when such crowding out occurs – but this is not one. Interest rates
> remain at record low levels. Besides, anyone who believes in the
> power of monetary economics must believe that monetary authorities
> can undo these effects. (There are other, even less convincing
> arguments: that taxpayers offset future liabilities by reducing
> consumption. It would have been nice if this had happened when the
> Bush tax cuts of 2001 and 2003 were enacted; instead, the savings
> rate fell ever lower until it reached zero.)
>
> A final argument invoked by critics of fiscal policy is that it is
> unfair to future generations. But monetary policy can have
> intergenerational effects every bit as bad. There are many countries
> where loose monetary policy has stimulated the economy through debt-
> financed consumption. This is, of course, how monetary policy
> “worked” in the past decade in the US. By contrast, fiscal policy
> can be targeted on investments in education, technology and
> infrastructure. Even if government debt is increased, the assets on
> the other side of the balance sheet are increased commensurately.
> Indeed, the historical record makes clear that returns on these
> investments far, far exceed the government’s cost of capital. When,
> as now, there is excess capacity in the private sector, such public
> investments increase output and tax revenues in both the short term
> and the long. If markets were rational, such investments would even
> lead a country’s cost of borrowing to fall.
>
> Given the complexity of the economic system, the difficulties in
> predicting how expectations will be altered, and the pervasive
> irrationalities in the market, there is no way the impact of any
> economic policy could be ascertained with certainty. There may be
> some circumstances in which the effect of monetary policy can be
> accurately gauged. But recessions of this depth come only once every
> 75 years. What is true in normal times may be of little relevance
> now, especially as central banks engage in unusual measures such as
> QE.
>
> To pursue austerity in the hope that monetary policy can reliably be
> used to undo any untoward effects, is, in short, sheer folly.
>
> The writer is University Professor at Columbia University and the
> recipient of the 2001 Nobel Memorial Prize in Economics. The
> paperback edition of his book ‘Freefall’ with a new afterword is
> being published this month
>