The WSJ's odd critique of the Fed
By Scott Sumner
This article in the Wall Street Journal left me scratching my head:
The Fed, Not the Market, Is Stifling Growth
That’s the title, and I eagerly looked forward to an explanation, perhaps a criticism of the Fed rate increase last December. Instead I found this comment:
Fed policies of zero interest rates and bond buying–quantitative easing–have not only failed to stimulate business investment. They have discouraged it through the misallocation of capital. This is contractionary because it starves entrepreneurship and thus productivity growth.
Well that’s certainly an unconventional hypothesis. But being unconventional doesn’t make it wrong–lots of my ideas are also unconventional. At this point a good newspaper would normally provide an explanation for their unconventional claims. This is what we get instead:
The North American Free Trade Agreement (Nafta) opened the Mexican economy to Canadian and U.S. imports in 1994. Many Mexicans lost jobs. Yet the country gained access to what it needed to modernize. Running water, salmon entrees, California wines and air conditioning were not standard fare here on the Mayan Riviera in 1985. They are now, and tourism has boomed.
Elite newspapers generally have editors. I wonder how the WSJ editor could have let that slip by. It does not seem to support the unconventional claim regarding monetary policy. Further along the essay does return to the Fed:
Left out of their analyses is the gargantuan role of the Federal Reserve’s antigrowth monetary and regulatory policies. Mr. Trump argued in September that the Fed’s eight-year policy of cheap credit is generating asset bubbles. But if he understood the problem he wouldn’t rail against Nafta.
So is that the explanation–an appeal to authority? Because Mr. Trump said so? But then why follow it up by disparaging Trump’s knowledge of economics, which suggests that he is in fact not an authority?
And even if Trump were right, why would an asset bubble reduce investment? The usual theory of asset bubbles (which I do not buy) says they boost investment (tech in 2000, housing in 2006, etc.) Again, no explanation.
Conventional wisdom holds that the Fed has flooded the market with credit by aggressively buying bonds and creating bank reserves on the Fed balance sheet. Yet when the Fed buys assets–such as government debt or mortgage-backed securities–it only records a short-term liability on the balance sheet. The reserves are on the books but don’t create any more credit in the real economy than if the Fed never made the purchase. Meanwhile it creates shortages of medium- and long-term assets in the market.
Finally there is an acknowledgement that the conventional wisdom is different. But still no explanation of how Fed policy is discouraging investment. Plus there’s a weird comment about a shortage of long-term bonds. Yet that’s clearly false—I can go out and buy a Treasury bond any time I like. And even if we generously assume that the author is confusing “shortage” with “reduction in supply”, there is no explanation as to why this would hurt investment. The standard textbook theory says investment is hurt when there is an increase in supply of government bonds. Indeed this theory, often called “crowding out of investment” is popular with conservative newspapers like the WSJ. So I’m still waiting for an explanation of how the Fed’s policy is reducing investment.
If there were a glut of credit in the real economy it would likely show up in bank lending as expanding businesses clamored for low-cost loans. Yet credit growth “has been dismally slow,” wrote David Malpass, president of the consulting firm Encima Global in a recent note to clients.
So credit growth has been slow. OK, but why link this to Fed policy? After all, haven’t we just a massive banking crisis? Haven’t banks just tightened their loan standards in the wake of the crisis? Haven’t we had Dodd-Frank—a regulatory monstrosity? Why single out the Fed. In the very next sentence, the author seems to agree with me:
The term structure of bank assets is partly to blame, but so is regulation–by the Fed and Congress, via 2010 Dodd-Frank legislation–which has made it difficult to lend to businesses, especially small ones.
Thus it’s not the low interest rate policy of the Fed, it’s their “regulation”. That sounds much more plausible.
The most creditworthy companies are using cheap money not in productivity-increasing ventures but to pay dividends, buy back stock or engage in other financial transactions. Fed policies, as Mr. Malpass wrote, are “reducing the credit available to smaller businesses and hurting GDP growth rather than stimulating it.”
And that’s it. An assertion that Fed policies are hurting business investment, but no explanation of how this is occurring. What is the mechanism? How does Fed policy discourage person A from extending credit to person B? You go all the way to the end of the article with a provocative headline, and the author doesn’t even attempt to back up this unconventional claim. What a let down! I like contrarian arguments—I wish the WSJ had provided the contrarian argument that they promised in their headline. I can’t criticize an argument that is not made.
This is the sort of article one gets when an ideology has reached the point of intellectual bankruptcy. The ideology is “Monetary policy is always and everywhere too expansionary.” If you adhere to that ideology, eventually you’ll have to tie yourself up in knots, attributing problems to “easy money” that are obviously not due to easy money. We’ve reached that point with the Wall Street Journal.
One can find many similar articles in conservative newspapers during the 1930s. I thought Friedman and Schwartz had put an end to that sort of conservatism. I guess I was wrong.
HT: Ken Duda