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24.09.2002, 18:00

Interest Rates Can Do Their Job! / Artikel mises.org, engl.

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Interest Rates Can Do Their Job!
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by Roger W. Garrison

[Posted September 17, 2002]

[img][/img] In
these times of faltering growth and worries about a relapse into recession, we
ask pointed questions about the competency of our leaders and policymakers. Is
Mr. Bush not doing his job? Is Mr. Greenspan not doing his? There is plenty of
finger-pointing to be done, but to bring the original culprit into view, we
must step back from the current politics and personalities and ask: Are
interest rates not doing their job?

Nearly a lifetime ago, John Maynard Keynes launched his
revolution largely on the basis of his belief that interest rates don’t do
their job and that the market economy is inherently flawed by this shirking.
So, just what, exactly, is their job? According to most of Keynes’s peers,
interest rates keep investment in line with saving. Responding to ordinary
market pressures in ordinary ways (supply and demand), interest rates can find
their own level, thereby providing just the right incentives and constraints.
Governed by this"natural rate of interest" (the pre-Keynesians
always used the singular to express the idea), the resources that the business
community commits to investment projects will be consistent with people’s
willingness to forgo current consumption. Such market-directed saving and
investment allow for healthy economic growth. Minor movements in interest
rates can make small corrections to the growth rate, immunizing the economy
against larger corrections in the form of recessions.

Keynes was blunt in rejecting wholesale even the possibility
that things might work this way. The classical economists, he claimed,"are
fallaciously supposing that there is a nexus which unites decisions to abstain
from present consumption with decisions to provide for future consumption"
(The General Theory of Employment, Interest, and
Money, London: Macmillan, 1936, p. 21).
Significantly, Keynes’s verdict of"no-nexus" left interest rates
up for grabs. If they weren’t doing their job anyway, maybe they could be
used for purposes of macro-management.

Keynes’s no-nexus macroeconomics is conducive to circular
reasoning and is replete with self-fulfilling prophesies. Optimism inspires
investment spending, which creates jobs and bolsters consumer demand; the
favorable market conditions translate into high profits, justifying the
optimism. But investment spending spurred only by unabetted optimism may not
be sufficiently strong in the eyes of elected officials and policymakers.
Lower interest rates engineered by monetary expansion may be called for. And
if the easy money gives rise to over-optimism (a.k.a."irrational
exuberance"), higher interest rates engineered by monetary contraction
may be in order.

Cool reflection on Keynesianism suggests some
self-fulfillment of a different sort. If interest rates are used as a policy
tool for abetting and abating investor optimism, then they cannot at the same
time perform their growth-governing function as envisioned by the classical
economists. Believing, as Keynes did, that interest rates don’t do their job
gives license to a policy regime in which interest rates cannot possibly do
their job.

Other elements of Keynesianism have similar self-fulfilling
qualities. The labor market is slow to adapt itself to conditions of reduced
investment spending. Wage rates, Keynes insisted, are sticky downward.
Investment spending must be stimulated or government spending must be
increased so that workers can be hired at prevailing wage rates. Here, too,
policy turns belief into reality. The Keynesian belief that workers will not
accept wage cuts begets a policy regime in which workers would be fools to
accept wage cuts.

"Keynesian stabilization policy" should be seen
for the oxymoron that it is. Keynesian policies do not stabilize the economy;
they Keynesianize the
economy. That is, a policy-driven economy mimics the unstable behavior that
Keynes thought to be characteristic of a market economy.

So now the central bank has ratcheted the federal funds rate
all the way down to 1.75 percent, the medium and longer-term rates coming down
to a lesser extent. Having failed to stimulate much investment, the cheap
credit has stimulated consumer spending instead. And neither Mr. Greenspan nor
anyone else is sure what to do next. Is the current 1.75 percent too high or
too low?

The answer, it turns out, is both. The 1.75 is too high in
light of the volatile and faltering asset prices and the paucity of
job-creating investment activities. But it is too low in the light of
plausible values for the natural rate of interest, which alone can be
associated with sustainable economic growth. Further, the too-high/too-low
diagnosis gives rise to the very uncertainties that dampen investor optimism
and hence whet political appetites for Keynesian stabilization policies.

Current interest rates are too policy-infected to have much
significance at all except as a basis for guessing about future interest-rate
policy. Keynes, we now should all see, did his job very badly. The Federal
Reserve will eventually have to abandon interest-rate targeting if the market
economy is to have a chance to right itself. (The Volcker Fed turned rates
loose in 1979 under very different but equally untenable circumstances.)
Interest rates can do their job, but they need some on-the-job training.
Ongoing debate in Washington and on Wall Street suggests that in the
foreseeable future, they’re not likely to get any.

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Roger W. Garrison, a professor of economics at Auburn
University and adjunct scholar of the Mises Institute, is the author of Time
and Money: The Macroeconomics of Capital Structure (Routledge,
2001). See his Mises.org Daily
Articles Archive and his many articles in The
Review of Austrian Economics and the Quarterly
Journal of Austrian Economics. An edited version
of this piece appeared in Barron’s (09/02/02) with the title
"Ditch the Keynesians: Why policy-infected interest rates must go."