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Source link: http://archive.mises.org/11275/truthful-interest-rates-and-federal-reserve-monetary-policy/

Truthful Interest Rates and Federal Reserve Monetary Policy

December 17, 2009 by

Once again, the Federal Reserve Open Market Committee has announced its intention to continue to artificially keeping interest rates “exceptionally low” for a “extended period.”

Missed in virtually all the commentaries is the key question: Should a central bank try to manipulate interest rates? Lost in all the debate over monetary policy is the fact that interest rates are market prices that are supposed to tell the truth: the truth about actual supply and demand conditions in financial markets.

I discuss the importance of interest rates — and prices in general — reflecting the reality of market supply and demand conditions in a new article of mine on, “Market Interest Rates Need to Tell the Truth, or Why Federal Reserve Policy Tells Lies.”

By preventing interest rates from telling the truth central bank policy inevitably sends out wrong signals about the real relationships between available savings and desired investment. The results are malinvestments, unsustainable bubbles and general economic harm.

Misguided monetary policy got us into the current business cycle, and the Federal Reserve is continuing the same mismanagement in the post-bubble era. Unfortunately, as long as we have central banks we will suffer from the ill affects of monetary central planning — distortions, imbalances, and inescapable “corrections” known as recessions.

As Ludwig von Mises once pointed out,

The essence of the market economy is that the economic actions of the individuals are not performed by order of the government but spontaneously by the individuals. This requires also that the money, the medium of exchange, be independent of political influence. if not, the coming years will be nothing but a series of failures of various government monetary and credit policies. To prevent this, it is necessary to make everybody realize that there are no Keynesian miracles possible, and that you cannot improve the situation of the people by credit expansion.

Richard Ebeling


Sally C. December 17, 2009 at 3:24 pm

I read your article and definitely agree. In the UK, the Bank of England has created £200 billion worth of ‘funny money’ via QE, and increased bank lending is seeping into the real economy pushing up house prices and CPI. Everyone thinks this is wonderful and I feel that I am in a fantasy land. I am not sure if there is ever going to be a day of reckoning. I have started to feel that my analysis of the situation is wrong. Perhaps interest rates should stay at 0.5% forever, allowing house prices to go on rising, dodgy companies to stay in business and sales of gas guzzlers to soar. Perhaps debt fuelled spending is the way forward after all! Please tell me I’m wrong!

Bogart December 17, 2009 at 4:06 pm

Do not make long term plans from short term up-ticks in stock market indexes or other aggregate measures. This is a very important time where the amount of debt is not ceasing but the people who buy the debts are going out of business.

I am putting new money in commodities and gold. Which amazingly has dropped below $1100 per ounce.

Bruce Koerber December 17, 2009 at 5:53 pm

Ludwig von Mises Wrote About ‘Independence.’

‘Audit the Fed’ deals with transparency.

‘Independence’ is conveniently used as a half-truth, as propaganda by all of the beneficiaries of the Fed – which of course wants to protect its secrecy. Transparency (auditing the Federal Reserve) shatters its secrecy.

With regards independence from political influence Mises wrote: “This requires also that the money, the medium of exchange, be independent of political influence. If not, the coming years will be nothing but a series of failures of various government monetary and credit policies.”

Mises is talking about the independence of the monetary system from the likes of a central bank, such as the Federal Reserve, because that is exactly the political influence that leads to the economic failures that spring directly and indirectly from their meddling.

Dick Fox December 18, 2009 at 12:29 pm

Those who believe that the FED can control interest rates live in an illusion. Just consider the current situation. The FFR is at or near zero, but short term and long term rates, ever Treasury rates are above 3%. Keynesians may ignore time preference but they cannot repeal it. Even the Keynesians in “real life” live by time preference.

Rich Phinney December 19, 2009 at 4:49 pm

In Human Action – the third subpart on Indirect Exchange, Demand For Money and Supply of Money – Mises is discussing cash holdings and the circumstances which may lead individuals toward choices of larger or smaller balances. He then explains as equivocation an error that “…made people confound the notions of money and of capital…”.

“Many economists avoid applying the terms demand and supply in the sense of demand for and supply of money for cash holding because they fear a confusion with the current terminology as used by the bankers. It is, in fact, customary to call demand for money the demand for short-term loans and supply of money the supply of such loans. Accordingly, one calls the market for short-term loans the money market. One says money is scarce if there prevails a tendency toward a rise in the rate of interest for short-term loans, and one says money is plentiful if the rate of interest for such loans is decreasing. These modes of speech are so firmly entrenched that it is out of the question to venture to discard them. But they have favored the spread of fateful errors. They made people confound the notions of money and of capital and believe that increasing the quantity of money could lower the rate of interest lastingly. But it is precisely the crassness of these errors which makes it unlikely that the terminology suggested could create any misunderstanding. It is hard to assume that economists could err with regard to such fundamental issues.”

This is not a minor point or a side bar. As we think about all the damage wrought by manipulations and interference with the lines of communication between consumer and producer, this is a revealing pause as he lifts his gaze from the immediate subject to contemplate the wider story. Then he explains that such error is not even likely to emanate from an economist. Is this not the velvet glove description of a political hack?

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