This Guy Says the Fed Has Got Everything Precisely Backward
What if by raising interest rates, the Federal Reserve is doing the opposite of what it intends? What if higher rates actually accelerate growth by injecting more money into the economy — rather than slowing growth by making it more expensive to borrow money? It would be a confusing mess.
Yet that’s precisely the situation we’re in, contends an unconventional hedge fund manager and entrepreneur named Warren Mosler.
On July 30, Mosler tweeted a chart that looked like the one I’ve created below. It shows the fall and rise of personal interest income over the past few years. When the Fed raises rates, interest income received by households rises. Mosler pointed out in the tweet that households are net savers on average, meaning that collectively, we earn more interest on our investments than we pay on our borrowings.
“Thank goodness for the rate hikes,” he wrote, because they are “helping keep us out of recession.”
I called Mosler last week to ask him about his tweet. He is one of the founders of modern monetary theory, a heterodox idea in economics that holds that governments with sovereign currencies such as the United States can spend as much as they want as long as their spending doesn’t overwhelm the economy’s supply capacity and cause inflation. But he argued that the case he made in the tweet is entirely consistent with mainstream economics: “This is not M.M.T.”
Mosler acknowledged that raising interest rates does have one depressing effect on the economy: All else being equal, higher interest rates make consumers and businesses less eager to borrow. But that effect may not be as large as is often supposed, he said. He pointed me to a working paper on the Fed website, published in 2014 and revised in 2015, that found “mixed evidence, at best” for the effect of changes in interest rates on business investment. (The Fed says that research in its working paper series “does not indicate concurrence either by other members of the board’s staff or by the board of governors.”)
In sum, Mosler argued that there’s so much debt in proportion to the size of the economy today that the positive effect of higher rates outweighs the negative effect. He said the Fed is as backward in its thinking as a hairdresser who says, “No matter how much I cut off, it’s still too short.”
This is a good time to say that I think Mosler is, on the whole, probably wrong. Still, it’s worth considering challenging ideas such as his just to keep yourself from falling into a mental rut. Plus, even if Mosler is wrong now, he could become correct in the future if debt — and thus interest — continues to grow as a share of gross domestic product.
I spoke or emailed with three mainstream economists who disagreed with Mosler’s conclusion while agreeing with his assertion that the Fed’s higher interest rates raise personal interest income.
The biggest fly in Mosler’s ointment is that while interest income goes up with higher rates, so do interest payments. Net interest income is only about 3 percent of national income, which is probably not enough to offset the negative effects of higher rates. Among those negative effects: When rates rise, household wealth tends to fall because stocks, bonds and housing lose value. Then there’s the effect on investment. Even if higher rates don’t harm businesses’ capital spending, they’re murder on housing construction, which is sensitive to higher mortgage rates.
Michael Woodford, an economist at Columbia University who is a leading voice on monetary policy theory, told me by email that higher interest rates make saving more lucrative in comparison to current spending. “Even when the private sector holds a lot of government debt, this effect can dominate,” he wrote. Also, he wrote, if the government sees it’s shoveling out too much money in interest, it could cut other spending or raise taxes, offsetting the stimulative effect of interest payments.
High government debt tends to increase tensions between the central bank, which sets interest rates, and the fiscal authorities, who are in charge of taxing and spending. “I’m afraid that if we’re heading into a period of heightened uncertainty about both monetary policy and the government budget, that’s not going to be very good for aggregate demand,” Woodford wrote.
Paul Krugman, an Opinion colleague who has a Nobel in economic science, wrote to me that he agrees with Woodford. He added: “A substantial part of added interest income from U.S. government debt would accrue to foreigners, not U.S. residents. The U.S. private sector would have to pay more to foreigners, too. Back of the envelope, this wipes out something like 60 percent of the income effect of higher rates.”
Sevin Yeltekin, the dean of the University of Rochester’s Simon Business School, told me by phone, “Like most things in economics, a lot of it is going to depend on the quantities.” If Mosler’s hypothesis is correct, she said, the effect would appear slowly. Rather than making higher rates outright stimulative, gains in personal interest income would gradually make them less contractionary, she said.
There’s even some daylight between members of the modern monetary theory brain trust on the topic. Randall Wray, an economist at Bard College who is a proponent of M.M.T., wrote to me that a big share of interest income goes to the wealthiest Americans, who have a lower propensity to spend what they earn. He added, “A country like Japan would be more likely to fit the Mosler scenario: high government debt, low private debt.”
Whether Mosler is right or wrong, he deserves credit for forcing the rest of the profession to keep examining, and testing, its assumptions about how the economy works.
Number of the Week
The estimated increase in consumer prices in Japan in the 12 months through July, according to the median prediction of economists surveyed by FactSet. Before April, Japan hadn’t seen 12-month rises this sharp since 2014, although still far below the inflation rates of Europe and the United States. The official number is set to be released on Friday, local time.
Quote of the Day
“It is far, far better and much safer to have a firm anchor in nonsense than to put out on the troubled seas of thought.”
— John Kenneth Galbraith, “The Affluent Society,” 40th anniversary edition (1998)
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