[Marxism] SHACKLE THE SADO-MONETARISTS!

[Matthew Dubuque <mdubuque@xxxxxxxxx>]

>From the newspaper of choice among British bankers:

COMMENT: Shackle these sado-monetaristsBy Gerard Baker
Financial Times; Mar 25, 2004



Sado-monetarism, a deviancy popular among certain central bankers and 
commentators in the 1980s, is out of the closet and back in respectable living 
rooms.

Even as the US economy is failing to generate sufficient growth to employ its 
expanding workforce, as the core inflation rate has fallen by a third in the 
past year, as the stock market slides below where it started the year and as 
the global economy is held hostage once again to war, Middle East terror and 
surging oil prices, there is a chorus of calls for the Federal Reserve to raise 
interest rates to squeeze the world's largest economy harder.

The Economist, a sado-monetarist of long standing whose complex psychology has 
been further tangled in recent years by an unhealthy bubble fixation (stock 
bubbles, housing bubbles, bond bubbles, dollar bubbles, hubble-bubble, 
trouble-bubble), is leading the charge.

An editorial two weeks ago said: "A rise in rates could help to avoid another 
dangerous bubble by warning investors and homebuyers that asset prices cannot 
rise for ever."

Hurt me!

The New York Times, a relatively new convert to self-flagellation, says the 
same thing. The paper condemned the federal open market committee's decadent 
decision last week to leave policy unchanged and called for an immediate 
increase in interest rates.

"Rates are so low that the Fed has plenty of room to move before being accused 
of adopting a restrictive monetary policy. It needs to get started."

Punish me!

If these two mostly innocuous institutions were alone in pursuing their habit 
in the secrecy of their own editorial boardrooms, we would not need to worry.

But there are signs they have some support. A number of financial market 
analysts are urging the Fed to raise rates. In Europe, while the economy 
stagnates, the European Central Bank's policymakers are still doggedly refusing 
to ease interest rates.

Indeed, in parts of European and American monetary policy debate it is the 
accommodative stance of the US, the only one of the three main areas of the 
industrialised world to have seen sustained growth for the two years, that is 
under fire. The recovery is essentially an artificial one, the argument goes. 
It has been built on unsustainable increases in housing prices and debt, all 
stoked by an overly accommodating monetary policy.

Fortunately the sado-monetarists are not in charge at the US central bank.

Of course, in providing the necessary liquidity to keep the US economy afloat 
in the past three years, the Fed has created some unwelcome side effects. But 
it is unlikely the alternative would have been better. Leaving rates unchanged 
over the past three years, or cutting them more gently, would probably have 
produced no growth at all; in those circumstances lower absolute debt levels 
would have been far more dangerous because the economy would not have been 
producing any income to service them.

Very well, say the critics, perhaps policy has been right up till now, but 
surely it is time to change.

It is true that the economy is recording stronger rates of growth than when the 
central bank lowered the Fed funds rate by 475 basis points between early 2001 
and mid-2003.

With productivity growth running at 3 per cent plus a year, the current 
long-run equilibrium real interest rate - the rate that is neither stimulative 
nor constricting - is probably about 3 to 4 per cent; at today's inflation rate 
that points to a nominal neutral rate of about 4 to 5 per cent.

The Fed funds rate is currently 300 to 400 basis points below that, imparting a 
powerful stimulus. If the economy is growing at roughly 4 per cent a year, why 
is the Fed not moving rates back towards normality?

By any measure the degree of unused capacity is still very large. The 
unemployment rate may be officially at only 5.6 per cent, but this is only 
because large numbers of discouraged workers have left the labour force.

A rough measure of the overall slack in the labour market is the proportion of 
the population in work - that still hovers around 62 per cent, 4.5 percentage 
points (or about 6m jobs) lower than at the peak of the boom in 2000. 
Industrial capacity utilisation is 76.6 per cent, down from more than 82 per 
cent at the peak three years ago.

This slack is reflected in the overall growth of gross domestic product. In 
only three of the past 14 quarters has output growth exceeded the estimated 
potential rate of about 4 per cent.

Despite the merest murmur of an uptick last week, inflation remains at about 1 
per cent, with a strong probability of further declines in the rest of the 
year. The surge in oil prices in the past six months is much more likely to 
have a deflationary effect through incomes than an inflationary effect through 
prices. And the geopolitical environment these days is hardly crying out for 
tighter policy.

Evidently, rates will have to rise as the recovery becomes more firmly 
established. But the keening for a tightening of monetary policy now is 
misplaced. Until the slack in the US economy starts to be significantly reduced 
- especially, until employment begins to grow rapidly - it is hard to be 
confident in the strength of the recovery. Without strong gains in employment, 
the economy will not generate the sort of self-sustaining income growth needed 
to work off the household debt incurred in the past few years at "normal" 
interest rates.

Sado-monetarists should be restrained before they do us all needless harm. 
gerard.baker@xxxxxx





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