Conceptual pitfalls and monetary policy errors

Wasn't that TARP? QE was supposed to be an unconventional jolt to the economy, TARP was the recapitalization of banks was it not...

The trouble with low interest rates is the incentives it provides. As others have point out, cheap credit has historically been correlated with inflating speculative financial bubbles because it promotes risk taking. Reason 1 to get of zero interest rates, reign in the speculative bubbles before they have the potential to become catastrophic.

But there is more at stake than what the economy, inflation and job figures are doing right now. The low rate crowd need to stop thinking of right here and now and about the next 10-20 years.

Bill Gross:
''The Fed is beginning to recognize that 6 years of zero bound interest rates have negative influences on the real economy – it destroys historical business models essential to capitalism such as pension funds, insurance companies, and the willingness to save money itself. If savings wither then so too does its Siamese Twin – investment – and with it, long term productivity – the decline of which we have seen not just in the U.S. but worldwide.''

What matters is the long term health of the economy, not the right here and right now, zero bound rates undermines the corner stone of capitalism and free(ish) markets because it prevents saving, investment and the productive allocation of capital.

So raise the darn rate, allow the market to set the rate by using the 2 year treasury, control inflation via altering reserve ratios rather than the overnight lending rate, and go back to being the lender of last resort.

Really good analysis and charts and supports the view that both world and US inflationary pressures do not justify a tightening of monetary policy in the USA or anywhere else that matters. BUT, it has been clear since Yellen arrived that the FED is keen to test whether the US money markets will work efficiently post the GFC and new regulatory framework. Recall that QE was resorted to (i.e. market intervention on the supply side) because the money markets were not working, or rather we could not be confident that they would work. It is not surprising then that the FED would like to get this second issue out of the way, so that interest rate mechanisms could be used instead of quantitative interventions.

So the FED has 2 reasons or justifications for wanting to move rates. By the way we know that money markets were broken because resorting to QE was just that, a last resort to get enough money into the system and re-capitalise the banks. For the layman it means having the confidence that Cash is Cash (low risk, low return). The GFC outcome was: high risk for Cash, high risk for banks, and the US financial system, and negative returns or even no returns for your Cash.

The FED is weighing up both of these issues and trying to deliver financial stability as well as low inflation.

Thanks, verv, for the comment. The money market is just the market for short term lending/borrowing. My point is that QE is the state providing supply to the market rather than the private sector. All of the new regulations are really untested in the face of high leverage and inflated assets which caused the crisis in the first place - Yellen and Carney both accept this position and it provides a case for testing whether the market will resume working. People have to feel confident with the financial system, that their money is safe at the banks, and a low yielding, low risk asset actually has those characteristics. BUT to build a case for increasing rates on that view alone is invalid. Why? Because the FED is also charged with avoiding deflation as well as inflation. I am not confident that the US economy has a firm enough footing to avoid a nasty fall-out from raising rates. When there are mixed signals from the economy you want to come down on the side of too easy not too tight. It is wishful thinking to try to deal with these 2 issues separately and I commend the Fed for recognising that. See also Bernanke's new book and the telling point that the Fed is already shouldering a lot. Washington's textbook for ECON 101 has huge chapters missing. I'm USD bearish given other countries are behaving more realistically.