June 17, 2016
That’s right, he’s upset that the Federal Reserve Board didn’t raise interest rates this week. He tells readers:
“Until a year or two ago, there was good reason for the Fed to continue with its extraordinary monetary policy. But with the U.S. economy nearly back to full employment, and incomes rising, and core inflation running close to 2 percent, it’s well past the time to start easing back on the stimulus by raising rates.”
The idea here is that we need to start raising rates or the labor market will get so tight that we will have problems with rising inflation. Or so it seems. But then we get:
“This isn’t about preventing future inflation — right now, all the signals are that that risk is pretty low. But it is about weaning the U.S. and global economy off an addiction to zero interest rates that have badly distorted the price of financial assets relative to the price of everything else.”
Okay, so we don’t actually have a problem with inflation, we have a problem with the price of financial assets being distorted. Pearlstein never quite fills in the details, but implicitly he is saying that we have problems with asset bubbles.
I am in fact a person who worries a great deal about asset bubbles, having warned about both the stock and housing bubbles, but I would like to see something in the way of evidence. Pearlstein could not be bothered to come up with evidence, he just wants the Fed to raise rates to throw people out of work because he is concerned. Maybe we can start by having his family members fired from their jobs. That should help in the bubble department.
Seriously, there are ways to look for bubbles. Are stock prices out of line with past trends? They are high, but if you adjust for the economy’s growth, they are lower today than they were in 2007, and almost no one worried about a stock bubble back then. (They are way below 2000 levels, adjusted for the growth of the economy.)
There is a similar story for housing prices. They have risen a huge amount from the trough of the recession, but they are well below their inflation adjusted bubble peaks. Furthermore, there has been a substantial rise in real rents as well. The vacancy rate has also fallen sharply. These factors suggest that house prices are being driven by the fundamentals of the market. (I will qualify this somewhat. There are markets, especially the lower tier of the California cities, where house prices do seem to be getting in bubble territory. This is a big issue and potentially really bad news for people buying into bubble-inflated markets, but it would be crazy for Janet Yellen to slam the brakes on the whole economy in order to pop these bubbles.)
So we have a complaint about the risk of bubbles, but no actual evidence, but then Pearlstein complains:
“Yellen’s fallacy is that it is necessary to wait until the economy is growing even faster, and inflation is even higher, and risks to the global economy have totally disappeared before moving toward more normal interest. What should be obvious at this point is that administering more monetary medicine won’t get us there. Indeed, the economy won’t be able to grow any faster than it is now until is weaned off the easy-money medicine and allowed to find a new and more sustainable equilibrium, one that can act as a foundation for higher growth.”
If there is any logic in this paragraph, I can’t find it. Somehow, if we raise interest rates, it will create the conditions for the economy to grow faster. How does that work? I know that if we raise interest rates we can expect fewer people to buy homes or refinance their mortgages, we can expect businesses and state and local governments to curtail investments, and we can expect a higher dollar to reduce net exports. Where does the faster growth come from?
Of course, since Pearlstein told us in the prior paragraph that the, “U.S. economy nearly back to full employment,” why would we want faster growth? If we are near full employment, wouldn’t faster growth just mean that we would just be seeing more inflation with little change in real output?
About the only plausible takeaway here is that Steven Pearlstein wants the Fed to raise interest rates. There is nothing resembling a coherent argument to back up this case.
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