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Source link: http://archive.mises.org/18017/its-not-working-so-of-course-we-must-continue-to-do-the-same-thing/

It’s not working so of course we must continue to do the same thing

August 9, 2011 by

The Fed in its policy statements said that growth this year has been “considerably slower than the Committee had expected.” So of course that means that they must stay the course for two more years of 0% interest.

{ 11 comments }

Virginia Llorca August 9, 2011 at 4:08 pm

And zero accountibility which is where the real problem lies.

Michael Menelli August 9, 2011 at 4:22 pm

Jeffrey, if 0% interest rates are not helping to speed economic growth, could you please explain how raising interest rates would speed growth?

jmorris84 August 9, 2011 at 4:50 pm

The problem is that a central planner is setting the rates at all. The free market should be setting interest rates.

nate-m August 9, 2011 at 5:11 pm

Yes.

The problem is that money is not the same as wealth. After the broken window fallacy the ‘money is wealth’ fallacy is the second most common.

Money functions as a medium of exchange. You can’t eat it, you can make cars with it, you can’t program with it, you cannot use it as a substitute for a Sunday afternoon with the kids. People get confused because we associate wealth with money so easily. It’s a very simple mistake to make.

Imagine this:

Imagine there is a island. On that island they are inefficient at producing grain because they have not yet invented a tractor or modern chemical fertilizers. There are a 1000 people living there, but there is only enough food, because of prolonged droughts, to feed 900 of them. So the price of bread rises to the point were there is always a group of people near starvation and spending ever larger percentages of their income on food.

So the problem that most people see is:
‘FOOD IS TOO EXPENSIVE, DO SOMETHING!’

The governments solution to this problem?
0% interest rates so everybody can borrow enough money to get all the food they want.

0% interest rates and all the money in the world does not produce jobs. It does not build factories, make tractors, discover new medicines, cause more doctors to be created.

All these things require capital and labor. As in capital _goods_.. as in physical resources acquired from the the planet and transformed into ever more useful and important items.

I will go on later as to why Market controlled rates will improve economy.

Michael Menelli August 12, 2011 at 7:35 pm

I understand the argument of not centrally-planning finances. However, Jeffrey’s argument concerned the Fed keeping interest rates low.

So, if the outcome of the meeting was not satisfactory, i.e. continuing to do the same thing, then how would doing something different (raising rates) yield any sort of growth?

J. Murray August 9, 2011 at 6:32 pm

The problem is that misallocated assets haven’t yet been liquidated to allow a proper alignment of capital goods to the market. Artificially lowering interest rates not only interferes with liquidation, it continues to present false signals that further borrowing and capital investment in weak activities is still a viable course of action. Hiking the interest rates will create incentives to pay off existing debt. Additionally, it will make unsustainable projects much more obvious and allow healthier business activities that can generate returns to bask in the spotlight instead of being crowded in with currently undesirable activities, like continued residential and commercial real estate construction.

Effectively, by holding down interest rates at 0%, this allows much lower margin projects, which have a higher risk of turning negative because of the razor thin margins. The low interest rates also incentive financial institutions to park their money with the Federal Reserve since they’re paying around 0.25% (or 0.5%, can’t remember off the top of my head at the moment) and basically just get free, no-risk money. If the Fed kicks up the rate to, say, 10%, the banking system will no longer find any value at parking their money in accounts that pay under 1% return and instead will seek out projects with profitability above 10% to lend against.

Franklin August 9, 2011 at 7:17 pm

Good summary.
Anyway, on the political spectum, one group of contituents will welcome the 0% uber-rate — consumers holding adjustable rate mortgages and who are still employed, just hanging on paycheck to paycheck; they are placated to again pull a red lever. Name of the game is to address each voting bloc.
For the voting bloc that represents savings and thrift, ignore. Most politicans can assume that risk, since those voters are dwindling day by day.

Walt D. August 9, 2011 at 8:34 pm

Artificially low interest rates create bubbles. (I am using the term bubble in the Didier Sornette sense – super-exponential growth). First we had NASDAQ. Then we had the real estate bubble. Now we have the Federal Debt bubble.
As J. said, the real estate bubble assets have not been liquidated – 0% interest rates allow banks with bad loans to hold onto them with very low carrying costs – if they had to liquidate they would go under. If the FED let short term interest rates rise to 5 or 6%, this would not only cause bank failures, the interest cost on the Federal debt would rise to close to $1 trillion and increase by $100 billion every year. Since the Federal Government cant really increase revenue without growing the private sector economy, they would face the same crisis as the European PIIGS.

bob August 9, 2011 at 7:02 pm

because then we’d have a solid currency and a more real savings, conditions that reduce investment uncertainty.

Dave M August 9, 2011 at 10:47 pm

I think the problem is that even the government confuses debt with wealth now.

I used to think that it was only people blinded by consumerism who thought a McMansion and an Escalade or two on borrowed money represented wealth. Now the entire western world does.

Ned Netterville August 10, 2011 at 10:19 am

Gold currently $1777; Dow down 400. Watching the excitement on CNBC, I heard a Morgan analyst explain that he was revising his target for gold from $1800 to $2500 (and noting that he may raise that further) because the federal government’s total liabilities were $65 trillion and would go to $100 or even $200 trillion if it did nothing to renege on its promises to pay. He also added that if the international financial managers did not come up with a “plan” to deal with governments’ (including Euro govs) liability problem when the IMF meets in November, gold would go much higher because that would signal that the only solution to the problem would be to monetize the debt. So far, except here at Mises, I haven’t heard any economist or analyst suggest that the problem was governments’ attempted control of money and banking.

Btw, who here thinks that the FED can hold interest rates at zero or near zero (or at any other figure) for the next two years? If there is anyone who thinks the FED is that powerful, I have a bridge in Brooklyn…etc. Maybe once upon a time, but no longer. The FED has lost its mojo!

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