Why Rate Cuts Are Definitely Not Justified
In his latest blog post, Nouriel Roubini argues the case for agressive interest rate cuts. I of course, completely disagree with that and think interest rates should be raised, particularly in America but also in most other countries. Roubini's post is mostly centered around replying to three valid arguments against rate cuts, namely:
a) such monetary easing will not prevent a hard landing and will only postpone the necessary restructuring after a reckless credit-boom driven asset bubble;
b) it will cause moral hazard and possibly create future bubbles;
c) it may lead to higher inflation.
I will comment on and respond to his replies to these arguments.
His reply to the first argument is that while a recession may be unavoidable, agressive rate cuts can reduce the severity and length of it and that is the right thing to do to avoid inflicting unnecessary pain on Main Street.
But this overlooks that first of all, the claim that monetary policy easing can reduce the severity of a recession is overrated. Perhaps the short-term effect is still positive, but the effect is very small as such move tends to boost the price of oil and other commodities and so reduce the purchasing power of Americans.
Secondly, Roubini does not even adress the point of necessary restructuring. The underlying problem is the overvalued asset prices and the insufficient savings of Americans caused by 20 years of inflationary monetary policies by Greenspan and Bernanke. By giving the American economy more of the same, we will see a long period of stagnation and/or more recessions.
With regard to the second argument, Roubini asserts that investors are already punished as it is and so moral hazard is not a problem.
But that argument does not hold simply because the losses are much smaller than they otherwise would have been. And with the gains sharply boosted during the boom while limited during the bust, it becomes rational for investors to create asset price bubbles, even though it is damaging to the economy.
Roubini then tries to deny that his policy would create more bubbles using two arguments. The first is that he advocates a symmetric approach to asset price bubbles, that is tightening policy during the boom as well as easing during the bust, new bubbles wouldn't be created. But that doen't change the fact that as long as central banks accomodates bubbles during the boom phase, which is what we've seen now and is likely to continue to see, policy would be very assymetric if the Fed cuts rates now and so create more problems.
The second argument is to try to minimize the role of monetary policy in creating the problem. I've already dealt with that argument when being made by Alan Greenspan and Sebastian Dullen so I won't repeat it again.
With regard to the third issue, inflation, Roubini admits that inflationary pressures are "elevated" right now, a statement of the all too obvious with the CPI up 4.3% and the PPI up 7.2% during the latest 12 months, but he argues that inflationary pressures will "fizzle away in short order once the US hard landing is in full swing".
This argument seem mostly based on his Keynesian notion of aggregate demand determining inflation as well on his belief that the U.S. recession will produce a global economic downturn which in turn will reduce commodity prices.
The Keynesian aggregate demand notion is of course complete B.S. as it does not explain the phenonema of stagflation, which is what we're seeing now.
As for the global effects, while the U.S. recession and the fear factor will certainly reduce growth in other countries, it will certainly not be enough to end the commodity price boom and turn it into a bust, especially since many commodities are noncyclical. China, the most important commodity consumer, still struggles to contain rampant inflation and will so easily be able to maintain growth in demand by simply abstaining from further increases in interest rates and reserve requirements.
So, contrary to Roubini, more of the thing that caused today's problem of excess debt, inflation and falling production will only produce more of excess debt, inflation and falling production.
a) such monetary easing will not prevent a hard landing and will only postpone the necessary restructuring after a reckless credit-boom driven asset bubble;
b) it will cause moral hazard and possibly create future bubbles;
c) it may lead to higher inflation.
I will comment on and respond to his replies to these arguments.
His reply to the first argument is that while a recession may be unavoidable, agressive rate cuts can reduce the severity and length of it and that is the right thing to do to avoid inflicting unnecessary pain on Main Street.
But this overlooks that first of all, the claim that monetary policy easing can reduce the severity of a recession is overrated. Perhaps the short-term effect is still positive, but the effect is very small as such move tends to boost the price of oil and other commodities and so reduce the purchasing power of Americans.
Secondly, Roubini does not even adress the point of necessary restructuring. The underlying problem is the overvalued asset prices and the insufficient savings of Americans caused by 20 years of inflationary monetary policies by Greenspan and Bernanke. By giving the American economy more of the same, we will see a long period of stagnation and/or more recessions.
With regard to the second argument, Roubini asserts that investors are already punished as it is and so moral hazard is not a problem.
But that argument does not hold simply because the losses are much smaller than they otherwise would have been. And with the gains sharply boosted during the boom while limited during the bust, it becomes rational for investors to create asset price bubbles, even though it is damaging to the economy.
Roubini then tries to deny that his policy would create more bubbles using two arguments. The first is that he advocates a symmetric approach to asset price bubbles, that is tightening policy during the boom as well as easing during the bust, new bubbles wouldn't be created. But that doen't change the fact that as long as central banks accomodates bubbles during the boom phase, which is what we've seen now and is likely to continue to see, policy would be very assymetric if the Fed cuts rates now and so create more problems.
The second argument is to try to minimize the role of monetary policy in creating the problem. I've already dealt with that argument when being made by Alan Greenspan and Sebastian Dullen so I won't repeat it again.
With regard to the third issue, inflation, Roubini admits that inflationary pressures are "elevated" right now, a statement of the all too obvious with the CPI up 4.3% and the PPI up 7.2% during the latest 12 months, but he argues that inflationary pressures will "fizzle away in short order once the US hard landing is in full swing".
This argument seem mostly based on his Keynesian notion of aggregate demand determining inflation as well on his belief that the U.S. recession will produce a global economic downturn which in turn will reduce commodity prices.
The Keynesian aggregate demand notion is of course complete B.S. as it does not explain the phenonema of stagflation, which is what we're seeing now.
As for the global effects, while the U.S. recession and the fear factor will certainly reduce growth in other countries, it will certainly not be enough to end the commodity price boom and turn it into a bust, especially since many commodities are noncyclical. China, the most important commodity consumer, still struggles to contain rampant inflation and will so easily be able to maintain growth in demand by simply abstaining from further increases in interest rates and reserve requirements.
So, contrary to Roubini, more of the thing that caused today's problem of excess debt, inflation and falling production will only produce more of excess debt, inflation and falling production.
posted by stefankarlsson at 6:57 PM
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