New and Different

I want to make it clear that I am talking about a new and different policy.

We have a new and different chairman at the Federal Reserve: Janet Yellen. But having a new and different chairman does not necessarily mean new and different policy.

From Brookings: Fed Unveils a New Job-Market Index by David Wessel:

In her testimony to Congress this week, Ms. Yellen said that “significant slack remains in the labor markets” and noted that wages are rising very slowly, all of which points to an economy which has not yet fully recovered from the Great Recession and still needs the sustenance of low interest rates.

Most people might evaluate Yellen's remark by focusing on whether or not "significant slack remains". Everyone is wagging the same tongue: The economy is recovering -- or it is not. It is time to raise interest rates -- or it is not. Inflation is just around the corner -- or it is not. Endless prattle, tiresome and nonproductive.

Open your mind.

This is not the thing: We have one policy that lowers interest rates to boost economic growth, and another policy that raises interest rates to fight inflation. That's not it.

This is it: We have a policy that raises or lowers interest rates, depending on whether we are more concerned about inflation or growth. It is one policy: We change interest rates. It is only one policy, with two phases you might say.

So if we toss aside one Fed Chairman and install another, hoping to see (or not to see) a change in the path of interest rates, this is not a change.

It would be a change if we were to abandon our policy of raising-and-lowering interest rates, and adopt some other policy or combination of policies in its place. That would be a change.

That would be new and different.

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.

- J.M. Keynes

David Wessel says Janet Yellen says that the economy "still needs the sustenance of low interest rates."

No, not "still needs". The economy always needs the sustenance of low interest rates. But this means we cannot raise interest rates as a policy tool to fight inflation. And that means we need a different policy tool to fight inflation.

See? This is what I mean by new and different. It isn't new and different if we push interest rates up instead of down. It isn't new and different if we hold interest rates down instead of letting them up.

It's not different if we exhale instead of inhale. It would be different if we suddenly got gills, or if we started absorbing oxygen through the skin and didn't need lungs anymore. That would be different.

We have to keep interest rates on the low side, always, so that the economy can grow. If you do not reject this idea immediately, you can think about it and you must say: But if interest rates remain low, there will be too much borrowing-and-spending, and we will get inflation.

You are right. So let us examine the problem that arises if we keep interest rates low: We get too much borrowing. The increased borrowing leads to increased spending. And the increased spending leads to inflation. Okay! That wasn't nearly as painful as I thought. Now...

If we keep interest rates low and remain permanently in a quasi-boom, we get increased borrowing and increased spending. We get increasing debt and increasing prices. This is undeniable. It happened in the 1960s and '70s.

And yet, did you notice in the years after 2008, there was a great deleveraging: debt stopped increasing and the money supply stopped growing. The Fed responded with bizarre emergency measures, boosting the quantity of money to avoid deflation.

People focused on paying down debt, and the threat of inflation disappeared. Did you notice? Paying down debt is a way to fight inflation.

Suppose we keep interest rates low, and as a result we see an increase in borrowing and the growth of debt. We see an increase in spending, and rising prices. But if we can only find a way to encourage a more rapid paydown of debt, we can have the increase in borrowing without seeing the growth of debt. We can get the economic vigor that comes from new borrowing without having to face the "significant slack" that arises from an excessive burden of debt.

And, if we find a way to encourage more rapid paydown of debt, the paydown of debt will drain money from the spending stream, limit the increase of spending, and limit inflation. If we can only find a way to encourage a more rapid paydown of debt.

Child's play. All we have to do is start weeding out the policies that encourage use of credit and accumulation of debt, and replace them with policies designed to accelerate the repayment of debt.

This is what I mean by new and different policy: Not interest rates that run high and low like the tides. Rather, a commitment to low rates and strong growth, permanently, and commitment to a tax policy that fights inflation by accelerating the repayment of debt and by preventing the excessive accumulation of private debt. Permanently.

This is what I mean by new and different.

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