Why the Fed can't drive

One of Milton Friedman’s favorite analogies about monetary policy was driving a car. He compared money creation by the Fed to pushing on the gas pedal. On flat ground giving the engine more gas makes the car speed up, so giving the economy more gas should cause it to accelerate as well. But giving the engine more gas by pushing on the pedal may allow the car to slow down when climbing a hill if the engine doesn’t get enough gas to overcome the gravity involved in climbing the hill.

Friedman’s point: interest rates tell us nothing about whether Fed policy is too tight or too loose. Only the speed of economic growth can tell us that. Low interest rates may be too high if the economy is climbing a steep hill, like a recession. On the other hand, high rates may be too low if the economy is speeding up, as it does near the end of an expansion. The grandchildren of Friedman use that analogy to argue for nominal GDP targeting by the Fed instead of price targets. The problem with the Fed’s driving strategy is that it never knows if it is climbing or descending a hill or how fast the economy is growing at the time it makes its policy decisions because of long lag times from policy decision to its impact.

Where's the growth?!!!

Decades ago an old lady yelled, “Where’s the beef?” when handed a burger in a fast food commercial. It became a catch phrase for occasions when people wanted to advertise that an idea lacked substance. So while the media proclaims the virtues of the current economy, many economists are asking, “Where’s the growth?”

The Bureau for International Settlements (BIS), the central bankers’ bank, recently issued a report card on the efforts of their client central banks to boost growth since the last recession and given them a failing grade. In the report “Unconventional monetary policies: a re-appraisal,” the BIS economists wrote:

We reach three main conclusions: there is ample evidence that, to varying degrees, these measures have succeeded in influencing financial conditions even though their ultimate impact on output and inflation is harder to pin down;

BIS Pushes ABCT Draws Fire

ABCT investing offers financial advise derived from the Austrian business-cycle theory, so to be confident in that advise investors need to be confident in the theory. The most visible institution promoting the theory today is the Bank for International Settlements (BIS). The BIS is the central bank for central banks based in Basel, Switzerland. Just as the Fed in the US coordinates the exchange of funds for commercial banks, the BIS acts as a clearinghouse that coordinates the international transfer of funds between the central banks of nations. 

Claudio Borio and William White of the BIS have used the ABCT for years to analyze events and create policy. Recently, the bank created a minor storm in the world of economics and central bank policy with the release of its 84th annual report. The report asserts that the loose monetary policies of the world's central banks as well as fiscal policies of governments have failed and continuation of those policies will prove harmful. Mainstream economists trashed the report. Martin Wolf of the Financial Times descended to juvenile language. Gavyn Davies, also of the FT,  wrote of the report,

The Bank for International Settlements (BIS) caused a splash last weekend with an annual report that spelled out in detail why it disagrees with central elements of the strategy currently being adopted by its members, the major national central banks. On Wednesday, Fed Chair Janet Yellen mounted a strident defence of that strategy in her speech on “Monetary Policy and Financial Stability”. She could have been speaking for any of the major four central banks, all of which are adopting basically the same approach.