Wednesday, 25 May 2011

In a recession, interest rates should be raised, not lowered.

We entered a recession a couple of years ago sparked off by excessive and irresponsible borrowing. And it’s not just the current recession that involved irresponsible borrowing: lax lending standards are common in the booms that preceed recessions.

So what was the reaction of governments round the world to the current recession, sparked off by lax lending? They cut interest rates with a view to encouraging more borrowing! Now there has to be something wrong there.

Of course reduced interest rates have a stimulatory effect. But that is not a good reason to cut interest rates where stimulus is required.

The Tinbergen principle is of supreme relevance here. The Tinbergen principle states that for each policy objective, one policy implement and one only is required (or words to that effect). And the implement chosen should obviously be the one most suited to the job at hand.

Now the fact that implement X is the one best suited to influencing policy objective X does not mean that implement X does not influence other policy objectives. For example, the main effect of interest rate changes is to influence the amount of borrowing and lending that takes place. By way of a side effect, this doubtless also influences aggregate demand: that is, for example, an interest rate reduction is stimulatory.

But that is not a reason to use interest rates to influence stimulus (unless interest rate adjustments are the BEST implement for influencing demand).

For the purposes of raising demand, the best and most obvious policy is to put more spending power into the hands of the ultimate source of all demand, that is households, or “Main Street”. So the correct response to the recession would have been to feed spending power into the pockets and Main Street residents and RAISE interest rates.

But of course the sub-human scum who make up the elite cannot bear to see more spending power in the hands of ordinary residents of Main Street. They’d rather stuff the pockets of the bankers with whom they socialise and inter-marry. And as to politicians, they are always mindful of the fact that (at least in the U.S.) its bankers who fund politicians’ election expenses.

Dean Baker is co-director of the Center for Economic and Policy Research in Washington. As he succinctly put it, “In elite Washington circles, ignorance is a credential”.

Afterthought on same day (25th May). The idea that interest rates should be RAISED in a recession is on second thoughts going too far, particularly as I advocated in earlier posts that interest rate should be determined by market forces. But certainly, there is not much of an argument for REDUCING rates in a recession.


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