Easy Money, Slow Growth

by Jerry O’Driscoll

In today’s Wall Street Journal, John Taylor explains why the U.S. recovery has been tepid while money growth has been very rapid. The recovery has set records for its weak pace, while money growth has set records for its rapidity. Taylor supplies some of the numbers.

Taylor continues an argument he made at the November 2012 Cato Monetary conference. It is the Fed’s policy that is causing the anemic recovery. To quote, “while borrowers like near zero interest rates, there is little incentive for lenders to extend credit at that rate.” He analogizes the Fed’s fixing interest rates to a policy of price ceilings on housing rents. Lenders supply less credit at the lower interest rates, as landlords supply less housing services under rent controls.

Taylor also notes that the Fed’s policy interferes with the signaling of the price system. It distorts capital allocation. Any decently trained micro economist would understand this. Why cannot the backers of the Fed’s policy?

In terms of the demand and supply of money, each round of quantitative easing has contributed to volatility in and the flattening of velocity. There is a dynamic between money supply and money demand. That is something that Milton Friedman explained long ago. In times of rapid inflation, fast money growth leads to a decline in money demand. (That is due to price-expectation effects.) Consequently, prices rise faster than the supply of money. Today, because rapid growth in the monetary base is an instrument for holding down interest rates, that growth in supply increases the demand for money. Hence, the record amount of excess reserves in the banking system.

Taylor’s piece answers “Market Monetarists” and all others who think Fed policy is just dandy, and whose only criticism is that Bernanke is a piker. They argue for even more growth in money, not understanding that their cure is the cause of the problem they are trying to solve.

Stock market guru Larry Kudlow is at least honest about Fed policy. Easy money and a “whiff of inflation” are nice stimulants for stocks. Wall Street does just fine, no matter the consequences down the road. Kudlow quotes “Market Monetarists” approvingly.

18 thoughts on “Easy Money, Slow Growth

  1. Kudlow is very aware and clear on this topic, and stocks may be the safest haven right now–but what happens when government bankruptcies create havoc?

  2. At the end of the article he also points out that the baneful effects of these policies lead the monetary planners to double down on their bad bets in a vicious circle.
    Am I correct in assuming that the Keynesian mainstream (if that’s what it is) doesn’t understand this because they think, following Keynes, that capital is almost an irrelevant afterthought rather than the literal building blocks and more of the economy? Keynes entitled ch. 15 or so of TGT “Sundry Observations on the Nature of Capital,” as if capital were the abandoned stepchild of the economy.

    Surely mainstream economists understand the harmful effects of price controls. Why do they give a free pass to the Fed Soviets?

  3. Taylor’s analysis has been spot-on from the beginning. The Fed’s QE programs have been counterproductive and have distorted normal market signals and incentives. Not only have the low interest rates distorted investment incentives for business but the quarter point interest paid by the Fed on bank reserves have further motivated banks to keep cash on deposit rather than lend it out.

  4. The study of Economics is Dismal, but far from a “science.” Those who attempt to apply economic theory must choose between the many abstractions available, all of which are based on a fragile understanding of cause and effect. One lesson derived from the application of economic theory over the last century is that unintended consequences alter the impact of top-down policies, rendering them unpredictable, frequently ineffective, and too often, harmful.

    Today’s economy needs certainty, fairness, and stability more than monetary and fiscal maneuvering. People will work, save, invest, and create new businesses if the playing field has simple rules that are understood and enforced. By and large, our government has juggled everything around so much that nothing is certain, or equitable. As a people we have learned that we must react to government policies rather than follow the principles of sound business and personal thrift.

    In this most recent mortgage melt-down, our governmental elite should have spent our time and money prosecuting the fraud on Wall Street and inside the belt-way rather than squandering stimulus money and bailout money. If they wanted to, they could cut the regulations in half, and still tighten up the rules against financial speculation and fraud.

  5. O’Driscoll, I would like to see you, or any Austrian economist, address the issue that the size of the credit expansion has no bearing on the depth of the crash. Steve Horwitz and others have made that claim, adding that the ABCT merely points to the upper turning point.

    However, check out this post at Free Exchange on the subject: “Oscar Jorda, Moritz Schularick, and Alan Taylor used macro-level data from 14 different developed countries from 1870 through 2008 in a recent paper to show that the amount of private borrowing in a boom predicts the depth of the subsequent bust…there is a very strong relationship between the growth of credit (relative to GDP) on the upswing, and the depth of the subsequent collapse in GDP on the downswing.”


  6. Roger,

    Thanks for the citation.

    ABCT is not strictly speaking about the recessions/depressions, but their origin. Many things, including especially policy responses to recessions, will affect the length and depth. Just think of the recent Great Recession and slow recovery.

    Others have found that credit growth — leverage — in the boom can affect he length and depth of recessions. Rogoff and Reinhart, This Time is Different is one example.

    I hope this helps.

  7. Still, there is a difference between freezing a price (the interest rate) to zero and injecting money that leads to such a low rate. So the analogy has its limits. I don’t think lenders are refusing to lend because the return is artificially low – investors are in the business of carry trade in emerging markets. Rather, banks are very skeptic about the prospects of repayment.

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