Jim Grant CNBC & Bloomberg interviews; Do central banks set incorrect interest rates?

Jim Grant made a couple of appearances in the public media recently. You can find a video interview at CNBC from Todd Sullivan's ValuePlays. You may also be interested to hear his Bloomberg audio interview conducted last week.

There isn't anything new per se. He sticks to his ideological views—that of Austrian Economics—and isn't happy with government intervention. Maybe I'm just a bleeding heart liberal but I don't share his ideology and actually think that Austrian Economists and their followers are mistaken on a huge swath of human affairs. In particular, AustEcons tend to ignore politics and human behaviour, and, instead, approach everything in life from an economic point of view. In any case, I'm reiterating my critical view because I do want to admit that they provide insight about one thing.

Just about the only major insight I gain from AustEcons is their criticism of the role of central banks in setting interest rates. As Jim Grant and others with similar views have suggested many times, it is possible that central banks—Federal Reserve, ECB, JCB, Bank of Canada, you-name-it—may be setting rates at mistaken levels. Jim Grant repeats this assertion again, suggesting that the near-zero rate being pursued by the FedRes may be too low, and if he were running the FedRes, would hike rates. I don't actually buy that view but it is, nevertheless, something to always keep in mind. If rates are too low, they will artificially boost asset prices and speculation in general; and vice versa. The criticism by AustEcons of central banks fixing interest rates is their belief that the central banks are distorting the pricing signal of the free market (in some sense, this is to capital markets what price fixing is to the physical goods markets.)

Do Central Banks Incorrectly Set Interest Rates?

Although I often think about whether the central banks are mistakenly setting rates—hence actually putting on the Austrian Economic thinking cap, temporary that it may be ;)—I am not certain that rates are incorrect in the long run for two reasons.

The first reason is my belief that the free market is stronger than any government in the long run (I actually find it bizarre that many AustEcons, who belive in the ultimate supremacy of the free market, to all of a sudden assume that central banks can dictate it.) My view is that the market will adjust and overpower the central bankers. It won't happen in an year, and there may be collateral damage, but it will eventually happen. If you look at history, you will note that the long term bond yields, which are the most important rate around, does not always follow the wishes of the central bankers. It wasn't even 4 years ago when the FedRes was trying to push up the long bond yields yet the market wouldn't accomodate their wishes (who knows why it was happening—popular theories at that time were the famous 'savings glut' theory and the 'China manipulation of US Treasury market' theory— but what matters is that it did happen.) If you believe in this line of thinking, it almost doesn't matter what the central bank does in the long run.

The other reason to not believe the 'incorrect interest rate' argument is because, even if the rate were set incorrectly, what if the distribution is random? That is, what if the central bank sets the rate "too high" sometimes, and "too low" at other times. The net effect in the long run would almost be zero. In the short run, the central bank may amplify or cushion changes in the economy but it is possible that they end up cancelling out everything in the long run. People with a deflation bias, such as most AustEcons, as well as gold bugs and hard currency advocates, might see the bank as erring on the "too low" side but to me, I think mistakes aren't necessarily skewed in any direction (the only exception is war, when governments generally force central banks to monetize their debt e.g. a huge chunk of the US govt debt issued during World War II was purchased by the Federal Reserve.)

In any case, even if you don't believe in Austrian Economics, it's worth thinking about what they say. The question right now is whether central banks incorrectly setting rates?


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