The argument can be summed up as “zero rates equals zero growth and zero inflation.” On this analysis, what John Maynard Keynes called “animal spirits” become depressed when borrowing costs stagnate at almost nothing. By leaving rates close to zero since the end of 2008, the Fed is basically telling companies and consumers to stay afraid of the economic outlook.
On Thursday, prior to the Fed decision, I asked Andreas Utermann, who helps oversee about $471 billion as global chief investment officer at Allianz Global Investors, what the effect on growth might be if the Fed jumped to normality in one leap instead of baby steps of quarter-point increases. “It wouldn’t be unambiguously bad,” Utermann told me. In particular, while short-term borrowing costs would leap to match the Fed’s move, Utermann said the cost of longer-dated money probably wouldn’t accelerate; the borrowing climate for business investment wouldn’t worsen until normal monetary policy produced inflation. He also said that the economic backdrop has changed, and that the world needs to get used to a new normal that might mean zero inflation persists for a long time.
I’ve had a bunch of e-mails in recent weeks on this topic from readers who disagreed with my articles that said the Fed should stay on hold because there’s still a non-negligible risk of deflation. Neil Grossman, who’s a director of Florida-based bank C1 Financial and was formerly the chief investment officer at TKNG Capital Partners, is a particularly eloquent correspondent on the topic.
Grossman uses the analogy of physics, where the weird stuff that happens at the quantum level (including what Albert Einstein called “spooky action at a distance”) forced theorists to rewrite their textbooks:
The problem with economists is that they fail to understand that standard economics is not appropriate as one approaches the zero rate bound. This is similar to what happened in physics over a century ago. In order to stimulate growth in the U.S., U.K. and globally, interest rates must be engineered to relatively normal levels.
Economics certainly doesn’t seem to be following its textbooks. The Fed’s balance sheet has swollen to $4.5 trillion from just $1 trillion when it introduced quantitative easing; yet consumer prices aren’t going anywhere.
So maybe the advocates of monetary-policy normalization are onto something.