Monday, January 26, 2009


Robert Lucas' Strange Faith in Bernanke

Details here. The intro:
Lately the Mises Daily may have given the impression that we just bash Paul Krugman. In the interest of balance, today I will cast aspersions on another Nobel laureate, the Chicago School economist Robert Lucas. As is typical among many "promarket" economists, the undeniably sharp Lucas inexplicably sees no problem with government price fixing when it comes to interest rates.

The Blackadder Says:

I have a basic technical question about how the "price fixing" for interest rates works. When the Fed sets the Federal Funds rate, does it do so by setting a price ceiling, a price floor, or both? That is, if the Fed announces, say, that the they are dropping the rate down to three percent, does that mean that banks can charge less than three percent, but not more? More than three percent, but not less? Or is three percent the only rate they can charge, and they have to charge that much on the relevant loans?
No, it doesn't set interest rates the way it sets apartment rents. I explain it here.
The Blackadder Says:

Thanks for the link. This answers my question, but raises another one. If it's true that the Fed doesn't directly control interest rates but uses open market operations to effect the change, then what's with the claim that monetary policy is useless once the interest rate hits zero. Can't the Fed just continue to buy up bonds, or whatever?
No matter how many reserves a bank has on deposit with the Fed, it's not going to loan them out at a negative interest rate. That's just handing money away.
The Blackadder Says:

Okay, let me use a silly example to see if I understand. It's like if the government had this special machine that could just create apples. Up to a point, the government could use the machine to drive down the price of apples by using the machine to create a bunch and then handing them out to apple farmers to sell. As the supply of apples rises, the price goes down, but this will only work up to a point. Once the price is driven down to near zero it doesn't matter how many apples you create, farmers aren't going to just give the apples away for nothing or pay people to take them off their hands.

Is that it, more or less?
Yep that's it, except if the government could create apples for nothing, that would be wonderful. But creating more fiat money doesn't increase real goods available for consumption.
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