According to the Kauffman Foundation, in 2015 more than half of young U.S. companies that applied for credit were turned down. The latter is a gentle reminder that the Federal Reserve’s power is quite a bit more mythical than real.
Figure that in 2015 the short rate for credit that the Fed aims to set was near zero. And had been that way for roughly six years. According to the mystics who believe the central bank is either essential to our economic health or the main barrier to it, the zero rate signaled easy credit. Too bad neither religion bothered to run its faith-based theories by actual businesses.
All of the above is healthy evidence that contrary once again to the musings of the Fed’s religionists and separatists alike, the central bank cannot alter the market-driven truth about the true cost of credit. No matter what the Fed does with the short rate, no matter its monetary machinations aimed at bending the long rates lower, the cost of credit will reflect reality. To believe otherwise, as in to believe that the Fed can make credit cheap by decreeing it so, is as silly as the belief that the Mayor of New York City could make apartments cheap and plentiful through the imposition of rent controls. Never forget that when we borrow money, we’re borrowing the goods, services and labor that money can be exchanged for. Sorry, but the Fed can’t decree access to any of the three “easy” any more than Bill DeBlasio could make NYC living affordable by decree.
All of this came to mind while reading former Fed Vice Chairman Kevin Warsh’s latest opinion piece about the central bank. Warsh is thankfully a skeptic about the Fed’s powers, but not nearly enough as his most recent musings attest.
While Warsh properly dismisses “r-star,” the “idea most in vogue in central bank circles” whereby central bankers aim to find “the neutral real interest rate at which monetary policy is neither accommodative nor restrictive,” he’s unwilling to dismiss what’s absurd in a way that might offend the near-monolithic view inside the economics profession that the Fed is actually important. He should. It’s well past time that someone who was once prominent inside the Fed state the obvious about how much economists and economic holy rollers alike overstate the central bank’s power.
The very idea that the Fed could engineer monetary policy that “is neither accommodative nor restrictive” isn’t a serious one, and Warsh knows it. Just as he wouldn’t take seriously plans from members of the political class to centrally plan production of televisions, smartphones and sirloin, logic dictates that he similarly look askance at the obnoxious conceit that permeates an economics profession bursting with the belief that credit access can be planned through skillful rate setting at central banks. Really? How?
While the 20th century revealed in bloody fashion just how incapable government bureaucrats were when it came to planning access to the most basic of goods (does anyone remember just how bare the shelves were in Soviet-era grocery stores?), it’s accepted wisdom that the Fed’s wise minds can set the price of accessing money exchangeable for everything. Except that it can’t.
Warsh writes that the “Fed’s search for the neutral rate suffers significant failings,” but that’s just the former central banker stating the obvious. Of course the Fed can’t find a neutral rate logically arrived at through the infinite decisions being made by billions of people every millisecond of every day. Rather than bluntly state how the Fed couldn’t ever possess even a microscopic fraction of the information necessary to hit the alleged “neutral rate,” Warsh oddly dissembled about the Fed being unable to hit “r-star” because of its inability to properly forecast “productivity growth,” what’s happening in Washington on the policy front, what’s happening among other central banks, and how the Fed will unwind QE. No. The Fed can’t divine the cost of accessing resources for the same reason that Donald Trump can’t set the price of Buicks: he lacks the information to set a price informed by infinite decisions made all over the world.
That central bankers quite laughably think they can set “interest rates principally by determining r-star” is the surest sign that they can do no such thing. Not only does basic common sense bolster the previous assertion, so does the fact that the “U.S. economy is booming” according to Warsh. Sorry, but centrally planned economies don’t boom. They always and everywhere contract simply because Rule of Man over Rule of Markets has never worked. It’s not that central bankers aren’t somewhat book smart as much as central bankers could never amass the information necessary to allocate resources in remotely optimal fashion. The Fed is at best a rate follower, not a rate setter.
Applying all this to Warsh’s rather limp dismissal of what vandalizes basic economics, we know that r-star is much less than consequential. Indeed, if the Fed’s vain attempts at central planning at all informed market realities then they would reveal themselves through the extreme opposite of booming growth.
It’s all a reminder that it doesn’t really matter what captivates the wannabe central planners on Constitution Avenue. They can continue to pretend that they influence the cost of accessing real resources, and economists with paychecks and international renown associated with the Fed’s wildly overstated importance will continue to comment on the Fed’s doings as though they matter.
But in a real economy that presently booms, credit will continue to be created in the market-economy, along with price of same. The Fed is a legend in its own rather delusional mind. Warsh must know this? Unknown is how long he’ll pretend that he doesn’t.