Extract from a speech by Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, in Seoul, South Korea on August 19, 2015:
There has been a significant decline in the long-run neutral real interest rate in the United States over the past few years.
This decline in the long-run neutral real interest rate increases the future likelihood that the FOMC will be unable to achieve its objectives because of financial instability or because of a binding lower bound on the nominal interest rate. Plausible economic models imply that the fiscal authority can mitigate this problem by issuing more public debt, although such issuance is not without cost. It is, of course, the province of the fiscal authority to determine whether those costs are worth the benefits that I’ve emphasized…
How we got in this mess
There are two critically important price signals in the economy — the interest rate and the exchange rate. Tampering with them encourages distortions, leading to instability.
- The Austrians were right: allow market forces of supply and demand to set a neutral interest rate.
- The main function of regulators should be to ensure that debt growth is consistent with economic (GDP) growth else the banks can distort the supply of money by excessive debt creation.
- The Austrians are also right about not running consistent fiscal deficits.
- The other important element is to avoid consistent current account deficits to achieve a fair exchange rate.
None of these (in my view) sensible guidelines have been adhered to for the last half-century. Financial markets are in a real mess and Austrian “hands-off” policies are now insufficient to get us out of it. The only real alternative is to employ “hair of the dog” remedies advocated by Keynes: run fiscal deficits, increase public debt and distort real interest rates. Remember that Keynes published his General Theory in 1936 when financial markets were in an even bigger mess. Even a broken clock is right twice a day (or twice a century in Keynes case).
As for the Monetarists, Market Monetarists present the best opportunity to get us out of this “Keynesian hell” and set us on the path to Austrian (and Monetarist) utopia.
Read more of Narayana Kocherlakota’s speech at Public Debt and the Long-Run Neutral Real Interest Rate | Federal Reserve Bank of Minneapolis.