Ignoring Natural Forces

There has been a lot of talk in the Fed about raising interest rates in the U.S. There’s one problem with that: the United Kingdom just did that with dire consequences, including increasing unemployment. Bloomberg is reporting that the U.K. has had the biggest manufacturing slump in their recovery because of higher interest rates.

Raising interest rates is designed to do one basic thing: tighten the supply of money to fight off inflation. Except England does not exactly have runaway inflation:

united-kingdom-inflation-cpi

Compare this to U.S. inflation rates, which have been struggling to consistently meet the Fed’s target of 2%:

CPI annualized

The Bank of England can’t seem to figure out the purpose of Econometrics – Economic Statistics which is used to measure things in the economy. From Bloomberg:

“The figures are ‘unlikely to be a true reflection of what is happening in the sector,’ said Rob Wood, an economist at Berenberg Bank and a former BOE official. It “is utterly at odds with strong survey readings.”

So it appears that the tools used to measure the economy is not actually measuring the economy, and policy is being based on guesswork. What’s the point of Econometrics again? The fact is that many economists in England aren’t sure what to do without more data, because they know that the data they have are flawed. And there’s lots of flawed data in the U.S.

The bigger question is this: is the BOE raising interest rates to a point that is “natural?” Paul Krugman came up with a curve last year that points to where “natural” interest rates should be in relationship with the zero lower bound. There’s no reason to thing that a “natural” interest rate cannot be higher than zero if IS shifts to the right:

Krugman IS-LM

If the “natural” interest rates are below the zero lower bound, then that’s where they belong. As Einstein said: “Look for what is, not for what you want there to be.”

Until there’s movement in M2V (velocity of money in transactions in the economy by everyday folks), there’s no real reason to make interest rates “unnatural.” Besides, letting some inflation creep in (maybe 3%) will give manufacturers reason to hire and produce; because what they make today for cheap will be worth more tomorrow.

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