My Letter to the NY Times re: Negative Interest Rates

To: letters@nytimes.com
Subject: Letter-to-the-Editor
Date: Thu, 24 Jun 2010 17:36:05 -0400

Re: When Caution Carries Risk

Dear Sirs:
Mr. David Leonhardt thinks that Fed Chairman Ben Bernanke is too worried about the stock market and not worried enough about unemployment and the economy in general. As a result, Mr. Leonhardt claims that Mr. Bernanke's caution carries the risk of a weak recovery that will harm millions of America's unemployed. Better to prime the old pump with yet another big dose of fiat money. To support his claim of a too-cautious Bernanke, Mr. Leonhardt refers to a San Francisco Fed report. According to its analytics, the Fed's effective benchmark rate today is a negative two- percent and it should be a negative five- percent. Negative interest rates, huh? This is a case in which one's firmly and, I might add, irrationally held economic outlook simply does not pass the test of common sense. Now it is true that a bank can lend at an effective negative rate. Let’s say that the inflation rate is ten percent and the bank lends at eight percent. Then its effective interest rate is indeed a negative two- percent. But only a person completely lacking in common sense or a dyed-in-the-wool Keynesian would advise the bank to lend at five percent in order to have an effective rate of negative five percent. The bank will slowly liquidate itself by transferring its capital to its borrowers. Yet this, apparently, is what Mr. Leonhardt advocates.

When an economic theory leads one to advocate that America liquidate its capital base in order to save itself, it is time to re-examine that theory. The Keynesian theory of lack of demand, which requires government stimulus via low rates and fiat money spending, should be discarded in favor of something that reflects reality. Artificially low interest rates in the early and middle part of the decade caused malinvestment that must be liquidated. We simply spent too much money producing stuff that people really didn't want or wanted less than other things. This is not a lack of demand of everything as much as a lack of demand for some things. Only a recession can cleanse the economy of this superfluous inventory and redirect it to meeting the real needs of the people. This takes two things--time and freedom. Zero or less-than-zero interest rates freeze malinvestment and prevents the economy from adjusting. Another big round of stimulus spending is the wrong policy.

Patrick Barron