On September 26th, Federal Reserve Bank (Fed) Chairman Jay Powell announced that the Fed Funds target rate is being raised above 2% for the first time since the Great Recession of 2008. The Fed uses this rate to steer monetary policy toward their favorite inflation, employment, and economic growth targets. The consumer price index and the unemployment rate are published by the US Bureau of Labor Statistics, and Gross Domestic Product (GDP) is published by the US Bureau of Economic Analysis. You get the connection.
Besides the 2% Fed funds interest rate, there is the 2% GDP growth number that is interesting. On October 29, 2012, the chief economist at Wells Fargo Securities, John Silvia, told the Risk Management Association that “Banks need to adapt to an economy in which 2% annual GDP growth is the new standard.” Then on June 11, 2014, Treasury Secretary Jacob Lew told the Economic Club of New York “Many wonder whether something that has always been true in our past will be true in our future,” referring to the Congressional Budget Office’s 2% annual GDP growth forecast.
And here it is four years later, and the most recent GDP growth calculation came in above 4% annually. What has changed? How could these public and private bank economists be so wrong? And what are they going to do about it?
4% Is the New Optimal Rate of Inflation
According to the Wall Street Journal, the 2% inflation target, another interesting coincidence, has been “a Holy Grail for the world’s major central banks. That is no longer the case given deep changes that have since reshaped the global economy.” Are they saying that corporate income tax reform and the political rejection of heavy handed regulation in the US and Britain have reshaped the global economy? Is 4% GDP growth merely an example of the Keynesian “animal spirits” that must be corralled by cooler heads at the Fed and the European Central Bank (ECB)? And what does a change in the inflation target accomplish?
Olivier Blanchard of the Peterson Institute for International Economics in Washington is calling for a 4% inflation target because in the event of a recession, it would be easier to cut interest rates. With a 2% target, it’s more difficult to cut interest rates, especially below zero. And sub-zero interest rates would be silly, right? Second, it would reduce the need for wage cuts in the event of a recession, but not for government employees. But what causes these anticipated downturns? If it’s not the government policies themselves, it must be these pesky animal spirits that caused 4% GDP growth in the first place.
Regarding debt, a higher inflation target makes it easier for borrowers to pay it off with cheaper money than what they borrowed, especially the government and their debt. The heck with the lenders and savers. And lastly, it would reduce the government’s debt to GDP ratio. The thinking here is that higher inflation means higher GDP growth, and this is true, except when its not, like in the 1970s. More realistically, its just another way to hide massive government debt accumulation.
0% is the New Optimal Rate of Inflation
According to Federal Reserve economist Anthony Diercks, “a mildly negative inflation rate would also have benefits, such as eliminating the cost of holding cash.” This idea may be a little harder to grasp, but it goes like this – when there is inflation, the cost of holding cash is its decreased purchasing power. One way to relieve all of us poor dumb slobs of our purchasing power risk (because of our large cash hoards) is deflation, meaning falling prices.
An added benefit of deflation would be negative interest rates. Meaning that if f you keep your cash hoard in a bank for safekeeping, it will earn a negative rate of interest, and you’ll have the privilege of paying the government bank interest on your deposits. But it doesn’t end there, the next likely step in helping with your cost of holding cash problem is to outlaw cash. This way your financial assets are always on deposit at a government bank, and only bank secured electronic purchases and sales will be legal. Otherwise, the central bankers would lose the interest income they’re charging depositors and the income taxes on the greedy capitalists. After all, its for the common good.
According to former Fed Chairman Ben Bernanke, “negative rates would be temporary and deployed only during severely adverse economic conditions.” Caused by what? And Vitor Constancio, Vice President of the ECB (where inflation and short-term rates have been zero or negative for about 3 years) says he has “no theoretical objections to a mild upward revision of the inflation target, however moving to a new target could undermine central banks’ hard won credibility.” Yes, credibility.
The Age of Complexity Worship
In all seriousness, fixing the price of money, setting inflation targets, government monopoly currencies, and measuring the wealth of an economy with Gross Domestic Product serves only one purpose – to expand the power of the Fed. This is because central bank governors are central planners, meaning self-proclaimed experts who disavow the productivity of free people and free markets. They believe themselves to be indispensable. Their rationale is that life has become too complicated for us poor dumb slobs.
To the Trump administration, raising the Fed Funds rate stifles economic growth. All administrations think that way. To the banks, higher rates mean higher net interest margins. They always think that way. Pundits defending the Fed’s move claim it leads to more normalized bond markets after ten years of artificially low rates. And normalized markets would be a great thing if that meant markets were free to float without interference from government econometric models.
For example, a huge flaw in these models is that they can’t anticipate innovation and the connectivity it inspires. The most recent inflation numbers came in a little lower than expected at 2.3%. This is because innovation is fueling even greater productivity, and helps keep prices stable, even in a hot economy. In other words – more and better and cheaper. It always works that way, and that bodes very, very well.