Matthew Dubuque mdubuque at yahoo.com
Fri Mar 26 11:17:57 MST 2004

>From the newspaper of choice among British bankers:

COMMENT: Shackle these sado-monetaristsBy Gerard Baker
Financial Times; Mar 25, 2004

Sado-monetarism, a deviancy popular among certain central bankers and commentators in the 1980s, is out of the closet and back in respectable living rooms.

Even as the US economy is failing to generate sufficient growth to employ its expanding workforce, as the core inflation rate has fallen by a third in the past year, as the stock market slides below where it started the year and as the global economy is held hostage once again to war, Middle East terror and surging oil prices, there is a chorus of calls for the Federal Reserve to raise interest rates to squeeze the world's largest economy harder.

The Economist, a sado-monetarist of long standing whose complex psychology has been further tangled in recent years by an unhealthy bubble fixation (stock bubbles, housing bubbles, bond bubbles, dollar bubbles, hubble-bubble, trouble-bubble), is leading the charge.

An editorial two weeks ago said: "A rise in rates could help to avoid another dangerous bubble by warning investors and homebuyers that asset prices cannot rise for ever."

Hurt me!

The New York Times, a relatively new convert to self-flagellation, says the same thing. The paper condemned the federal open market committee's decadent decision last week to leave policy unchanged and called for an immediate increase in interest rates.

"Rates are so low that the Fed has plenty of room to move before being accused of adopting a restrictive monetary policy. It needs to get started."

Punish me!

If these two mostly innocuous institutions were alone in pursuing their habit in the secrecy of their own editorial boardrooms, we would not need to worry.

But there are signs they have some support. A number of financial market analysts are urging the Fed to raise rates. In Europe, while the economy stagnates, the European Central Bank's policymakers are still doggedly refusing to ease interest rates.

Indeed, in parts of European and American monetary policy debate it is the accommodative stance of the US, the only one of the three main areas of the industrialised world to have seen sustained growth for the two years, that is under fire. The recovery is essentially an artificial one, the argument goes. It has been built on unsustainable increases in housing prices and debt, all stoked by an overly accommodating monetary policy.

Fortunately the sado-monetarists are not in charge at the US central bank.

Of course, in providing the necessary liquidity to keep the US economy afloat in the past three years, the Fed has created some unwelcome side effects. But it is unlikely the alternative would have been better. Leaving rates unchanged over the past three years, or cutting them more gently, would probably have produced no growth at all; in those circumstances lower absolute debt levels would have been far more dangerous because the economy would not have been producing any income to service them.

Very well, say the critics, perhaps policy has been right up till now, but surely it is time to change.

It is true that the economy is recording stronger rates of growth than when the central bank lowered the Fed funds rate by 475 basis points between early 2001 and mid-2003.

With productivity growth running at 3 per cent plus a year, the current long-run equilibrium real interest rate - the rate that is neither stimulative nor constricting - is probably about 3 to 4 per cent; at today's inflation rate that points to a nominal neutral rate of about 4 to 5 per cent.

The Fed funds rate is currently 300 to 400 basis points below that, imparting a powerful stimulus. If the economy is growing at roughly 4 per cent a year, why is the Fed not moving rates back towards normality?

By any measure the degree of unused capacity is still very large. The unemployment rate may be officially at only 5.6 per cent, but this is only because large numbers of discouraged workers have left the labour force.

A rough measure of the overall slack in the labour market is the proportion of the population in work - that still hovers around 62 per cent, 4.5 percentage points (or about 6m jobs) lower than at the peak of the boom in 2000. Industrial capacity utilisation is 76.6 per cent, down from more than 82 per cent at the peak three years ago.

This slack is reflected in the overall growth of gross domestic product. In only three of the past 14 quarters has output growth exceeded the estimated potential rate of about 4 per cent.

Despite the merest murmur of an uptick last week, inflation remains at about 1 per cent, with a strong probability of further declines in the rest of the year. The surge in oil prices in the past six months is much more likely to have a deflationary effect through incomes than an inflationary effect through prices. And the geopolitical environment these days is hardly crying out for tighter policy.

Evidently, rates will have to rise as the recovery becomes more firmly established. But the keening for a tightening of monetary policy now is misplaced. Until the slack in the US economy starts to be significantly reduced - especially, until employment begins to grow rapidly - it is hard to be confident in the strength of the recovery. Without strong gains in employment, the economy will not generate the sort of self-sustaining income growth needed to work off the household debt incurred in the past few years at "normal" interest rates.

Sado-monetarists should be restrained before they do us all needless harm. gerard.baker at ft.com


Do you Yahoo!?
Yahoo! Finance Tax Center - File online. File on time.

More information about the Marxism mailing list