Monetary Policy Is Failing

 Monetary Policy Is Failing

Summary:

  This article is posted on August 4, 2017 by Yves Smith, it does a fine job of explaining, in a layperson-friendly manner, why one of the key tenets of mainstream economics, the loanable funds theory, is bunk. It’s nevertheless incorporated in models widely used by central bankers and Serious Economists like Paul Krugman. It also shows how it has failed in practice. But what is more revealing is it was shown to be incorrect long ago yet orthodox economists refuse to give it up.

  The author believes that Monetary policy has become the first line of defense against economic slowdowns — it’s especially taken the driver’s seat in combating the crisis that began in 2007. Headlines everywhere comment on central bank’s (CB) decision-making processes and reinforce the idea that central bankers are non-political economic experts that we can rely on during downturns. They rarely address, however, that central banks’ monetary policies have failed repeatedly and continue to operate on flawed logic. When central banks ease the supply of credit, they rely on banks to transmit the benefits to the broader economy by making loans, handling trades and moving money between people, companies and countries. Shrinking, unprofitable banks hobble that transmission channel.

  Yves Smith called it the debunked “loanable funds” theory: that when money is on sale, businesses will go out and invest more. That theory was partially debunked by Keynes and dispatched by Kaldor, but zombie-like, still haunts the halls of central banks. And we’ve seen the failure of this tidy tale in the wake of the crisis. Providing super cheap money has not induced businessmen to run out and ramp up their operations. Instead, one of the biggest outcomes has been corporate financial speculation: issuing debt to buy back their own shares.

Review:

Many market participants believe that promoting economic growth and employment is one of the core tasks of the Fed. In their view, the monetary policy should be reconciled to the cycle, and in a reasonable period of time to make the economy out of recession.

Yves Smith argues that the Fed policy has suffered a painful failure in this sense. The reason is that the US economy has been out of recession for seven years, but gross domestic product (GDP) growth has not yet reached more than 3%. He also believes that the Fed has actually admitted this failure.