Larry Summers: Artificially Low Interest Rates Cause Bubbles
Tyler Cowen finds this quotation from Larry Summers writing in the Washington Post:
The second strategy, which has dominated U.S. policy in recent years, is lowering relevant interest rates and capital costs as much as possible and relying on regulatory policies to ensure financial stability. No doubt the economy is far healthier now than it would have been in the absence of these measures. But a growth strategy that relies on interest rates significantly below growth rates for long periods virtually ensures the emergence of substantial financial bubbles and dangerous buildups in leverage. The idea that regulation can allow the growth benefits of easy credit to come without cost is a chimera. The increases in asset values and increased ability to borrow that stimulate the economy are the proper concern of prudent regulation. [Bold added.]
I have two reactions:
(1) Remember a few months ago when I said that Larry Summers (and Krugman, who was jokingly accusing Summers of plagiarism for taking Krugman’s position) was confirming the Austrian position, and some of you clowns denied that they said low interest rates lead to bubbles? Well, I hope you email Summers and tell him he just misrepresented himself.
(2) Summers and I agree on the positive question: The string of bubbles in recent decades is due to the textbook policy response of the Fed lowering interest rates in response to a bad economy. We just disagree on the normative question: Summers thinks an economy going through successive bubbles is better (“far healthier”) than one spared a string of bubbles, whereas I hold the opposite judgment.
Bob, I don’t think Krugman would agree with Summers’ statement that “the idea that regulation can allow the growth benefits of easy credit to come without cost is a chimera”. I think Krugman believes that loose monetary policy has the potential to cause bubbles, but he doesn’t believe that it will necessarily lead to any bubbles at all, especially if there’s sufficient regulation in place.
I’d propose a new regulation that stops all bubbles from forming, then the CB will not have to worry about low interest rates causing bubbles anymore. The whole contend of the regulation should be:
“You shall not overprice assets!”
Of course if you doubt that this is enough, then you can optionally hire an omniscient, righteous, selfless and incorruptible being to oversee that regulation.
(I know that you, Keshav, may not believe that “sufficient” regulation can stop bubbles or to be more exact, that regulation may reduce costs on net (costs of having bubbles versus costs of having regulation that prevents wealth creation…) Of course not artificially and arbitrarily reducing interest rates and having market determined interest rates instead is out of the questions)
“(“far healthier”)” depends on whether you want status quo to remain or not. If you consider yourself wealthy and secure, you want nothing to change regardless of principle.
“No doubt the economy is far healthier now than it would have been in the absence of these measures.”
Um, I doubt this, especially given what he says immediately after it.
Let’s say a patient wanders into a doctor’s office. This patient has cancer and has been undergoing chemotherapy. As a result of the chemo, they feel tired, they’re vomiting constantly, they’re losing their hair, etc. The doctor says, “Hey, great news. I can cure all of those symptoms! We’re just going to take you off this chemotherapy! The tiredness, vomiting, and the hair loss will all stop. You’ll be far healthier than you were while you were undergoing it. Now granted, this will cause your cancer to grow and spread, but hey, you want to be healthier now don’t you?
That’s right Bob, we have plenty evidence that bubbles are a monetary policy creation rather than a financial system creation as some statists think.
http://organizationsandmarkets.com/2013/10/28/easy-money-and-asset-bubbles/
“The idea that regulation can allow the growth benefits of easy credit to come without cost is a chimera.”
Paging Post Keynesians and Minskyians!
I expect there will be silence from the clowns.
Idiots! You need cheap credit to cure the monstrous problem of sticky prices caused by administered prices! Bubbles can be easily prevented by proper financial regulation like as was in effect during the GOLDEN AGE of CAPITALISM 1945-1970.
Bob Rodis, that’s you isn’t it?
It’s not clear from that quote that he agrees with the Austrians who assign 100% of the blame to govt. However, since Summers is known to be a patsy for Wall Street, it would not be a surprise to hear him take such a position. Now we know why so many did not want to see him chair the Fed.
I presume by that he does not actually mean “lower capital costs” as discovering an amazingly cheap and efficient way to build a factory or something like that. I would guess that he means that by lowering interest rates it is therefore easier to borrow money and get started on building that factory… which might give the appearance that the factory is therefore cheaper to build.
But what does lowering interest rates *really* do to the actual cost of building a new factory? Given that we don’t believe in creating something out of nothing, how does it work in physical terms?
What karaoke song should I do for the final?