Fed Inflates Capital Markets!

In an email newsletter sent out by the Wall Street Journal called Macro Horizons, Michael J. Casey appears to grasp a point about monetary policy that few other mainstream economists can get a grip on, while Austrian economists have taught it for decades: inflationary monetary policy benefits the rich. He wrote,

Easy money translates into gains for those who are rich in assets, especially financial assets, and that excludes a large swath of the population [italics in the original].

I assume Casey is a mainstream economist because the main point of his post was the need for central banks to maintain monetary “stimulus.” The quote above follows this:

The subject of disinflation is the focal point of Wednesday’s data, where we are being reminded of its nonexistence in the industrialized world and of the risk that it could morph into outright deflation. This is most evident in Wednesday’s CPI data out of Europe, which is why the notoriously stimulus-shy Deutsche Bundesbank insiders even came around to telling the Journal Tuesday that they were considering backing actions at the European Central Bank’s June meeting to attack the disinflationary trend. But we’re likely to see the same later in the U.S. producer price data and in the U.K., whose economy is otherwise growing strongly, the Bank of England indicated that it still sees no great impetus for inflation to breakout. There was a time when this scenario of growth, coupled with low inflation, was seen as a “Goldilocks” scenario, a perfect not-to-hot, not-too-cold combination where policy would stay accommodative but gains could be had in the economy and markets. But the longer we flirt with deflation – which translates most directly into near-zero wage growth – the more that the adoption of hyper-accommodative policies tends to exacerbate the other great scourge of our age: inequality. 

Of course, those who understand Austrian economics can benefit from Fed monetary policy just as the rich do. As for inequality, Casey should pursue his last thought about monetary policy inflating assets to its logical conclusion, as Austrian economists have done. Inflating assets, such as the stock and real estate markets can benefit the rich only if they get the new money first, before prices have risen. They get the money first because the Fed deals with a small group of large banks, which in turn deal with a small group of preferred banks and customers. It’s no secret that the largest gains in income accrued to the financial services sectors over the past two decades.

Casey has deviated from mainstream economic theory by violating the sacred assumption that all new money reaches everyone in the nation at the same time. Clearly, Casey is beginning to grasp that it doesn't. But the next question is “Who gets new money last?” That would be the working poor who get the new money in the form of a small wage increase long after the prices of all assets and consumer goods have risen.

The working poor get hurt again when the unsustainable boom produced by the Fed turns into a bust with massive unemployment, most of which destroys the lives of the working poor. 

Diminishing marginal returns

Mainstream economists who demand massive monetary stimulus to rescue the economy know that the Fed has tried that for the past six years. They merely think it has not done enough. But those economists also ignore the micro principle of diminishing marginal returns. The principle states that increasing inputs to a process will generate smaller returns. Applied to monetary pumps, it means that each injection of new money will benefit the economy by increasingly smaller amounts until the benefit disappears. No "threshold" exists over which monetary policy must leap before it becomes effective. Whether it's a call for greater fiscal spending or money creation, mainstream macro emphasizes it's divorce from micro, and reality. 

Tyranny of the short term

Austrian economists don’t ignore the short term benefits of inflationary monetary policies. Those policies do stimulate the economy in the short run. Austrians complain about the medium and long term effects of such policies. Hayek wrote in Profits, Interest and investments that 

It may perhaps be pointed out here that it has, of course, never been denied that employment can be rapidly increased, and a position of “full employment” achieved in the shortest possible time by means of monetary expansion-least of all by those economists whose outlook has been influenced by the experience of a major inflation. All that has been contended is that the kind of full employment which can be created in this way is inherently unstable, and that to create employment by these means is to perpetuate fluctuations. There may be desperate situations in which it may indeed be necessary to increase employment at all costs, even if it be only for  a short period-perhaps the situation in which Dr. Bruning found himself in Germany in 1932 was such a situation in which desperate means would have been justified. But the economist should not conceal the fact that to aim at the maximum of employment which can be achieved in the short run by means of monetary policy is essentially the policy of the desperado who has nothing to lose and everything to gain from a short breathing space. (PII 63-64)

 Among many flaws, mainstream econ suffers from farsightedness and nearsightedness. Concerning the flaw of their farsighted focus on the very long run Keynes wrote, "Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again." But Hayek reminds us that a fetish for the short term does even greater damage. The following passage from pages 409-410 Pure Theory of Capital is long, but very important for our time as well as Hayek's. I encourage the reader to have to patience to read it all:

The scope of monetary policy is very wide indeed. But the problem is not so much what we can do, but what we ought to do in the short run, and on this point a most harmful doctrine has gained ground in the last few years which can only be explained by a complete neglect — or complete lack of understanding — of the real forces at work. A policy has been advocated which at any moment aims at the maximum short-run effect of monetary policy, completely disregarding the fact that what is best in the short run may be extremely detrimental in the long run, because the indirect and slower effects of the short-run policy of the present shape the conditions, and limit the freedom, of the short-run policy of to-morrow and the day after.

I cannot help regarding the increasing concentration on short-run effects — which in this context amounts to the same thing as a concentration on purely monetary factors — not only as a serious and dangerous intellectual error, but as a betrayal of the main duty of the economist and a grave menace to our civilisation. To the understanding of the forces which determine the day-to-day changes of business, the economist has probably little to contribute that the man of affairs does not know better. It used, however, to be regarded as the duty and the privilege of the economist to study and to stress the long effects which are apt to be hidden to the untrained eye, and to leave the concern about the more immediate effects to the practical man, who in any event would see only the latter and nothing else. The aim and effect of two hundred years of' continuous development of economic thought have essentially been to lead us away from, and " behind ", the more superficial monetary mechanism and to bring out the real forces which guide long-run development. I do not wish to deny that the preoccupation with the "real" as distinguished from the monetary aspects of the problems may sometimes have gone too far. But this can be no excuse for the present tendencies which have already gone far towards taking us back to the pre-scientific stage of economics, when the whole working of the price mechanism was not yet understood, and only the problems of the impact of a varying money stream on a supply of goods and services with given prices aroused interest. It is not surprising that Mr. Keynes finds his views anticipated by the mercantilist writers and gifted amateurs: concern with the surface phenomena has always marked the first stage of the scientific approach to our subject. But it is alarming to see that after we have once gone through the process of developing a systematic account of those forces which in the long run determine prices and production, we are now called upon to scrap it, in order to replace it by the short-sighted philosophy of the business man raised to the dignity of a science. Are we not even told that, "since in the long run we are all dead", policy should be guided entirely by short-run considerations? I fear that these believers in the principle of après nous le deluge may get what they have bargained for sooner than they wish.