Sunday, August 28, 2011

SWNIDish Stimulus? Be Contrarian!

As an utterly amateur economist, we wonder whether it's past time for a very different kind of monetary policy to effect stimulus of our moribund economy.

Specifically, we wonder whether higher interest rates are in order.

"What?" responds a public drunk on elixir of Keynes. "Higher rates will suffocate what economic activity there is! Are you mad, SWNID?"

Yes, on the demand side, it might be a little tougher. But consider first that lower rates are not making for more borrowing and the economic activity connected to it. Banks are loathe to lend, and businesses are loathe to borrow. Cash is being hoarded in record amounts these days.

But what if the Fed began gradually raising rates.

First off, the dollar would strengthen considerably. That, in turn, would reduce inflation for producer prices, specifically for petroleum and other raw materials that the American economy needs to make products to sell to the world. Conventional wisdom says that a weaker dollar will make exports cheaper and so stimulate export industries. But when about half of our domestic economy's imports are petroleum and other raw materials, the difference is at best negligible. People buying with higher valued currencies currently have an advantage over Americans, an advantage that would go away if rates were raised and the dollar appreciated. That says nothing about the additional dollars in the pockets of consumers if oil prices drop with dollar appreciation, as they historically have.

Second, savers would have a better reward for their savings, and all would have more of an incentive to save. Not only would America's retirees have some money to spend, America's workers would have a better growing sense of prosperity as their net worth creeps up. The difference is that interest, not appreciation of assets like homes or stock-based mutual funds, would be fueling the renewed confidence. So for the long term, we get a stronger consumer base, but even in the short term, we get a more confident cadre of consumers, at least those who save instead of borrowing.

Now, who would suffer in all this? For one, banks would no longer be able to make money on the fact that they can borrow from the Fed essentially for free. Some might fold as a result. But might others be forced into more aggressive lending that would in turn offer some prospect of economic growth? What good is a bank that simply makes money on the Fed's zero-interest dole?

Of course, Uncle Sugar would have to pay higher rates too. That outcome, however, depends on the world finding something other than Treasurys as a parking place for its fear; otherwise, the rate at which the government can borrow will remain historically low. But if rates on Treasurys do rise, there's all the more of an imperative for the government to reverse the pattern of the last 2.5 years, in which "stimulus" has been used as the Trojan horse for increasing the federal baseline on the way to making more of the economy dependent on federal patronage and so more firmly capital-D "Democratic." So this too may be, at worst, painless in the short run but still highly beneficial in the medium and long run.

We are attracted to this idea by all the wrong reasons, namely, our contrarian tendency to assume that if a huge majority believes something, it is probably false. But at this stage, who can realistically say that more of the same will yield something better than it already has?


JB in CA said...

I don't know. Some of this sounds a little too close to my own views for me to take it seriously. There must be something wrong with it.

Actually, I shouldn't call them my own views. I was introduced to them by David Goldman, who has been arguing for the last couple of years that slightly higher interest rates would help solve some of the problems you mentioned. But he also advocates tax incentives for small businesses and entrepreneurs, since historically they are the ones who have been primarily responsible for creating jobs that help initiate periods of recovery after a recession. (Large corporations, by contrast, continue to shed jobs during those periods to avoid risks and maximize profits for their shareholders.) So in addition to the monetary policy you're proposing, he'd include a fiscal policy—much different from the one we've taken in the last couple of years—to stimulate those sectors of the economy that are more likely to lead us out of a recession and, by doing so, give the large corporations an incentive to do something other than sit on their hoards of cash.

Thaudit said...

I actually like your views on this. Insightful. (Not want i want to hear since I want to purchase a home soon) but fiscally it would prompt me to get out of my chair and borrow (you know before the rates get too high).