Shocking ignorance at the St. Louis Fed

Yi Wen, the Assistant Vice President of the St. Louis Fed and his Research Associate, Maria A. Arias wrote an article which blamed the great recession of 2008 on, “the private sector’s dramatic increase in their willingness to hoard money instead of spend it.”  The evidence that they give is the collapse in velocity of the monetary base:

mbThe fact that someone is holding on to money longer without spending it (a drop in velocity) certainly is evidence of hoarding.  But Wen and Arias are completely clueless about who to blame.  They argue that the private sector had an “unprecedented increase in money demand”  so that people could “hoard money instead of spend it.” Wen and Arias go on to say:

[W]hy then would people suddenly decide to hoard money instead of spend it? A possible answer lies in the combination of two issues:

  • A glooming economy after the financial crisis
  • The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds

In this regard, the unconventional monetary policy has reinforced the recession by stimulating the private sector’s money demand through pursuing an excessively low interest rate policy (i.e., the zero-interest rate policy).

This is shockingly clueless.  First, it is not “people” in the “private sector” who are hoarding this particular measure of “money.”  It is entirely the banks hoarding reserves.  Fed economists should know this because the Fed literally houses all the bank reserves. Secondly, the monetary base is mostly bank reserves and that is not really money.

Thirdly, they blame LOW interest rates for causing hoarding.  This is contrary to basic supply and demand as illustrated by the Wicksellian loanable funds graph at the bottom of my article about hoarding. Standard monetarist theory says that overly high interest rates cause hoarding, not interest rates that are too low.

Fortunately, most of the Fed’s economists are smarter than this, but it is scary how many “hard money” people there are like this at the Fed.  They are always predicting higher inflation and calling for higher interest rates. They probably were taught the new-classical models* of the economy that give them no ability to understand real-world recessions. In this case, Wen and Arias say that, “inflation in the U.S. should have been about 31 percent per year between 2008 and 2013.”  Rather than looking at Keynesian models that predicted that inflation would stay low, Wen and Arias blame the private sector for hoarding money.

Money hoarding has certainly been a problem, but it is the banks that are hoarding reserves that are causing the above phenomena, not “people” in the “private sector” and one reason they are doing it is because the Fed is paying them to hoard the money. For the first time in history, the Fed is paying interest to the banks for hoarding this money.

Again, the problem is that the interest rate is too high, not too low.  The Fed should cut this interest rate back to zero to encourage the banks to stop hoarding.

*Wen got his PhD from the University of Iowa which has tended to favor useless “freshwater” or “new-classical” macroeconomics, so perhaps that is why he didn’t learn these basic useful macroeconomic ideas.

Posted in Macro

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