Certain economic equations and regularities make it
tempting to assume that there are simple cause-effect relationships
that would allow a policy maker to directly manipulate prices and
output. While the Fed can control the monetary base, the
behavior of prices and output is based on a whole range of factors
outside of the Fed's control. Except at the shortest maturities,
interest rates are also a function of factors well beyond monetary
policy.
Analysts and even policy makers often ignore
equilibrium, preferring to think only in terms of demand, or only in
terms of supply. For example, it is widely believed that lower real
interest rates will result in higher economic growth. But in fact, the
historical correlation between real interest rates and GDP growth has
been positive - on balance, higher real interest rates are
associated with higher economic growth over the following
year. This is because higher rates reflect strong demand for loans and
an abundance of desirable investment projects. Of course, nobody would
propose a policy of raising real interest rates to stimulate economic
activity, because they would recognize that higher real interest rates
were an effect of strong loan demand, and could not be used to
cause it. Yet despite the fact that loan demand is weak at
present, due to the lack of desirable investment projects and the desire
to reduce debt loads (which has in turn contributed to keeping interest
rates low), the Fed seems to believe that it can eliminate these
problems simply by depressing interest rates further. Memo to Ben
Bernanke: Loan demand is inelastic here, and for good reason. Whatever
happened to thinking in terms of equilibrium?
Hussman expects the effect of expanding the monetary base will be to...
"have little effect except to provoke
commodity hoarding, a decline in bond yields to levels that reflect
nothing but risk premiums for maturity risk, and an expansion in stock
valuations to levels that have rarely been sustained for long (the
current Shiller P/E of 22 for the S&P 500 has typically been
followed by 5-10 year total returns below 5% annually). The Fed is not
helping the economy - it is encouraging a bubble in risky assets, and an
increasingly unstable one at that. The Fed has now placed itself in the
position where small changes in its announced policy could have
disastrous effects on a whole range of financial markets. This is not
sound economic thinking but misguided tinkering with the stability of
the economy."