I was trying to come up with a way to describe Raghuram Rajan’s latest argument on why interest rates should go up despite high unemployment and quiescent inflation — but Mike Konczal, a fellow with the Roosevelt Institute, saved me the trouble.
As Mr. Konczal writes in his blog, Rortybomb, it’s Calvinball — making up new rules on the fly to justify whatever you want.
Mr. Rajan, a professor of finance at the University of Chicago’s Booth School of Business, writes in his monthly syndicated column: “Clearly, someone is paying a price for ultra-low interest rates: the patient and uncomplaining saver. … As with any tax and subsidy, the net effect depends on whether those taxed cut back spending less than those subsidized. Economists have sensibly advocated that China raise the interest rates that it pays on bank deposits so that Chinese households earn more and consume more. Some Japanese now wonder whether their ultra-low interest-rate policy could be contractionary.”
Mr. Rajan pulls two tricks in his column. First, he makes interest-rate setting sound as if it’s a form of price control — and by the way, the critique of China’s low rates on deposits is that they’re controlled rates kept below the true price of credit in the economy, not that overall monetary policy is too loose. So, for the record, open-market operations that move rates are nothing like price controls.
Second, he simply takes it for granted that there’s something unnatural about very low rates right now.
But why? It’s obvious that desired saving (or rather, the amount people would want to save if we were anywhere near full employment) is currently greater than desired investment.
That suggests that the natural rate of interest right now is negative; only the zero lower bound keeps it from going there.
But the main point, as Mr. Konczal points out, is that all of Mr. Rajan’s arguments for higher rates would seem to apply just as well at a non-zero Fed funds rate.
“Imagine short-term interest rates were actually at 2 percent right now … If you looked out at the economy, would you lower interest rates? Given unemployment, inflation, off-trend G.D.P. and all the other conditions of the economy, do you think the economy is heating up too fast or too slow?” Mr. Konczal wrote on June 10.
He continues: “Rajan, who previously argued that there was something special about being at zero that made the market go sideways, apparently wouldn’t reduce the short-term rates given the state of the economy.”
Let me make the case even more strongly than Mr. Konczal does, and ask you to imagine that the world looks the way it does, but that the Fed funds rate was, for some reason, 4 percent. Would you argue that the Fed should respond by raising rates? That would be crazy — and it’s no less crazy to call for higher rates starting from here.
Let me add that at the last Group of 30 meeting I heard several people — people who have influence, and should know better — making arguments quite similar to Mr. Rajan’s.
This is a game of Calvinball that could have real negative consequences.
Backstory: Rewarding the Spenders
A recurring element in Bill Watterson's comic strip series “Calvin and Hobbes,” which follows the antics of a gifted 6-year-old and his anthropomorphic stuffed tiger, is a game called Calvinball, in which the duo invents new rules as they play.
But while Mr. Watterson concluded the series in 1995, Mike Konczal, an influential economics blogger and Roosevelt Institute fellow, maintains that Calvinball is still being played by conservative critics of expansionary monetary policy in the United States. He holds that they are continually inventing new rules beyond the Federal Reserve's dual mandate of maximum employment and stable prices. Mr. Konczal and other commentators have warned that the end result could be monetary policy that is detrimental to a recovering global economy.
The catalyst for Mr. Konczal's and other commentators' arguments is a recent column for Project Syndicate by Raghuram Rajan, a former chief economist at the International Monetary Fund.
Calling for higher interest rates, Mr. Rajan said that ordinary people are the real victims of Federal Reserve chairman Ben S. Bernanke‚ expansionary monetary policy, because they earn less interest on their savings. “The interest rate is a price for the savings that are transferred to spenders,” he wrote. “To the extent that the Fed manages to push this price down, it taxes the producers of savings and subsidizes the spenders of savings.”
Commonly accepted rules guiding monetary policy are based on the notion that interest rates should be raised when the economy is overheating and lowered when it is in a slump. The effects of the latest recession are therefore to blame for a weak recovery as is the case with the United States, where rates are near zero rather than an overzealous central bank. But Mr. Konczal contends that the logical conclusion following from Mr. Rajan's thesis is that the rule should be to reward savers and punish spenders, regardless of the employment rate.
“It's not about rewarding the good people and punishing the wicked, it's about stabilizing growth, prices and maximum employment without overheating the system,” Mr. Konczal wrote on June 10. And it isn't clear to me what rules or rough guidelines are motivating the argument here. Hence, Calvinball.
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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.
Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including “The Return of Depression Economics” (2008) and “The Conscience of a Liberal” (2007). Copyright 2011 The New York Times.