Tuesday, March 18, 2014

The Downside of Monetary Policy

Many times in recent years I've seen liberal commentators (<cough>Kevin Drum</cough>) say things like, "we need looser monetary policy ... it can't hurt". Unfortunately, that's not true.

Monetary policy is really a very blunt tool.  The central bank can raise or lower interest rates, but the effects are unpredictable.  If we rely on monetary policy to repeatedly boost the economy over a secular period where the economy needs repeated boosts due to globalization, we're likely to see interest rates fall to 0 and stay there, while overinvestment in interest rate sensitive sectors such as housing results in repeated booms and busts in these sectors.  Indeed, that is exactly what we have witnessed over the last 30-some years.

I ran across an article with data and commentary along this line discussing the housing market in the U.S. over the last several years:  http://www.alhambrapartners.com/2014/03/18/departing-science/.  Excerpt:
New York Fed president William Dudley said in an interview with the Wall Street Journal this month that “persistent headwinds” to growth explained why the economy would be unable to bear much higher interest rates in the years ahead...  Headwinds are nothing more than the economy doing something other than modeled...   
Monetary policy’s most fervent channel lies through mortgage finance... Unfortunately, mortgage issuance is off nearly 60% in less than a year since the word taper entered the mainstream... there is something very wrong when a relatively small increase in mortgage rates leads to such a dramatic decline
Real estate construction has a macro component to it that has already seen some reversal in the GDP figures (a tailwind turning headwind, as it were). It looks like that is deepening still further, but more importantly, there is the looming possibility of a second, albeit smaller, housing bust forming in such close proximity to the first.
Headwinds are not some exogenous factor, they are monetarism put into practice.
Here's another post from Alhambra Partners demonstrating the recent ineffectiveness of monetary policy... 


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