Tuesday, December 25, 2012

Krugman Cult Continued

A Commenter to Paul Krugman’s “When Prophecy Fails” wrote, “2) You didn't really respond to my argument that it is the softness in the economy that is holding interest rates down, not the Fed's actions. Another way to look at this is to ask what has happened to the $3 trillion in cash that the Fed has injected into the economy by buying Treasuries. People are happy to leave them in near-zero interest earning bank deposits. And banks can't find borrowers in the private sector.”

I'll take a stab at responding to point 2. To the extent that the Fed is holding down short-term interest rates DUE to the softness of the economy then yes. So, it is the Fed that determines short-term rates. But, it would be nice to know what interest rates would be had we a truly free market.

The $3T sits primarily in bank accounts doing nothing except perhaps earning a pittance for its owners.

But low interest rates typically signal to the market that long-term investments are a good idea. The problem lies in the ability of the Fed to unwind all the QE programs and take the $3T OUT of the economy before it get used to fund another boom/bust and potentially inflationary cycle.

The Federal Reserve may function based on Keynesian Economics but although it is loath to admit it, it is aware of the Austrian implications.

No comments: