Is price stability immoral?

By Felix Salmon
June 25, 2012
Stabilizing prices is immoral".

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Steve Waldman is one of the most original thinkers on the internet, and I highly recommend you read his latest piece, “Stabilizing prices is immoral“. You might never think about central bankers quite the same way again, and indeed you could start thinking that they judge themselves according to how assiduously they service the interests of the rich and well-employed.

When central banks see consumer prices rising too fast, they raise interest rates to bring inflation back down under control. That’s a deliberate slowing of the economy as a whole, for the especial benefit of the kind of people who have a particular interest in low inflation. The beneficiaries, here, are lenders, and people who can’t assume that their salaries will rise with inflation. Meanwhile, debtors — and even the economy as a whole — would have been better off, at least in the short term, if the central bank hadn’t acted at all.

Now central banks act the other way, too: they cut interest rates when demand is too low. And when that happens, as Waldman says, the tables are turned:

Whether monetary or fiscal, an antideflationary response to a supply shock implies an increase in aggregate demand which helps keep marginal workers employed. Creditors and secure-but-stagnant job-holders lose out, as the increase in purchasing power they otherwise might have enjoyed via deflation is distributed to other parties.

So, what goes around comes around, right? Not so fast. I’m reminded of when I spent a lot of time looking into the equity premium — the excess return that investors get for holding stocks rather than bonds. Given that the equity premium exists, why doesn’t it get arbitraged away? A lot of the reason is that the premium has an annoying habit of turning up exactly when you don’t need it, and disappearing exactly when you do. Stocks do well when the economy is booming and lots of people have jobs and are getting raises. That’s when they don’t need to turn to their nest eggs. Conversely, in recessions, when people get laid off and need cash, stocks have a tendency to fall quite sharply, even as bonds do rather well.

As a result, there’s a good reason why investors like having bonds in their portfolio, even if they expect those bonds to underperform: there’s much more value to something which does well in bad times than there is to something which does well in good times.

And this is Waldman’s thesis about price stability: it helps out rich lenders in bad times, and helps out poor borrowers just when they don’t really need it.

Under a symmetric policy, creditors and the securely employed purchase their insurance against bad times by foregoing some benefit during good times. That’s still a fine deal. Their overall risk is reduced.

But the opposite is true for debtors, taxpayers, and marginal workers. Just when these groups need a break, when the economy is bad due to an adverse supply shock, they are hit with additional costs in the name of price stability. Sure, when things are good all over, they get some frosting on their cake. Their highs are higher, but their lows are lower. Symmetrical price targeting turns debtors, taxpayers, and marginal workers into high-beta speculators on the state of the broad economy, while reducing the risk exposure of creditors and secure workers. It represents a vast subsidy, a transfer paid in risk-bearing, from debtors, taxpayers, and marginal workers to creditors and secure workers.

But, I’m not completely convinced. Adverse supply shocks notwithstanding, the general rule is that central banks cut rates in bad times, and raise rates in good times. When they cut rates, that’s bad for lenders and good for borrowers. When they raise rates, that’s good for lenders and bad for borrowers. So if you’re a rich lender, you’re unhappy in bad times and happy in good times. Far from insuring the rich against bad times, the central bank seems inclined to kick them when they’re down.

What’s more, over the long term, economies tend to do better if they grow steadily: volatile inflation does no one any favors, compared to the alternative.

Still, I like Waldman’s idea of a government savings account paying 0% real interest to anybody with less than $200,000 to invest. It should be easy to invest your savings so as to protect their purchasing power; in fact, it’s hard. Back in 2010, I asked the world to invent a Gross World Product swap: basically, big multinational corporations could fund themselves at the rate of growth of the world as a whole, while risk-averse investors could buy a proxy which would very closely track global purchasing power. That hasn’t happened yet. So for the time being, a simple index-linked savings vehicle would be a great start. And, as Waldman says, it would be easy insurance against exactly the kind of supply shocks that Waldman is worried about.


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“Adverse supply shocks notwithstanding, the general rule is that central banks cut rates in bad times, and raise rates in good times. When they cut rates, that’s bad for lenders and good for borrowers. When they raise rates, that’s good for lenders and bad for borrowers.”

They only cut as much as is necessary to maintain price stability. Under NGDP targeting, they would be cutting even more, or cut the “virtual fed funds rate target” (as Miles Kimball calls it).

Falling rates in bad times are good for lenders because it makes their existing portfolio of loans more valuable. It’s true that returns on new loans they make will be low, but in bad times nobody few people will be borrowing, and lenders will be less willing to lend.

Posted by guanix | Report as abusive

A TIPS bond fund isn’t THAT different from the “0% real return savings account” that you describe. Except that these days, TIPS have a negative real return.

And second guanix. Falling rates are good for lenders. Wider margins on existing loans, more refinancing activity. Rising rates are bad for lenders.

Posted by TFF | Report as abusive

For that 0% real interest account, TIPS in a Treasury Direct account are pretty close. The minimum is now only $100. The main hassle is that if you want to sell before maturity, you have to transfer them to a bank or broker to sell them for you.

Posted by spamvikktim | Report as abusive

Anyone who thinks that price stability is immoral has learned nothing from history, and is too young (or too self-involved) to remember the 1970s. WIN buttons, anyone?

Posted by Curmudgeon | Report as abusive

The fight between hard money and soft money was the central economic issue in 19th century America, culminating in William Jennings Bryan’s Cross of Gold speech.

Remembering something about history is now original thinking?

Posted by Potamacus | Report as abusive

I sense a bias in his argument. Another word for “rich lender” is “saver”. That is, someone who’s savings are either in bank deposits, bonds or equities (all forms of lending). Additionally, consistant with his argument, a large portion of these savers will be retirees. When you define the “rich lenders” as retirees living off their savings, it conveys a different message.

Posted by DCUK | Report as abusive

The belief that increasing interest rates will slow a growing economy and decreasing them will spur growth needs to be relegated to the urban legend bin. It works that way sometimes, but not always, as recent events have demonstrated.

Interest rates of essentially zero have not stimulated the economy, mainly because even if capital is free (for those who qualify, anyway), it’s not enough reason to invest if you don’t believe there will be an appropriate return. Conversely, sufficiently high growth will more than offset high interest rates, and will not dissuade investors or speculators.

Even worse, increasing interest rates to curb inflation can have the opposite effect – products that are capital intensive to produce will cost more.

Rather than using the cost of capital to control growth, the availability of capital should be used. It would also have the added benefit of limiting the expansion of bubbles, as debt couldn’t be used to finance their inflation.

In ny case, it shouldn’t be a question of morality. Assigning a moral value to fiscal or economic policy is a slippery slope to government intrusion into personal values (o.k., laugh here, as if that isn’t already happening).

Posted by KenG_CA | Report as abusive

I feel “amoral” would be a better word here. A mechanism has no conscience or cross to bear, so cannot be judged as good or bad; those who use such a weapon as interest rates could say they are morally trying to protect the wealth of the many, but as politicians usually delay too long before acting because the direct effect of interest rate changes is to alter the trailing indicator of unemployment then that hesitation could be described as immoral. But Price Stability itself? Just because it can be harmful doesn’t in itself make it immoral. That is why I believe, in this context, amoral is the best adjective.

Posted by FifthDecade | Report as abusive

An income target, which ngdp or even better ngdi essentially is, would probably make more sense. There is really little difference between an income target and an inflation target in normal times, it is only during downturns that the measures would diverge. Price stickiness leads to worse performance of an inflation target then while an income target is just what is needed to allow the economy to adjust rapidly.

Posted by MyLord | Report as abusive


As someone who works for a conventional lender (a mid-sized credit union), I can emphatically say that falling or prolonged low rates are NOT good for healthy lending.

You may a good point about the the rates on your existing stock of debt, but the rolling maturity for most small cap lending is much shorter than you’d think. Say 36-months on average for autos, a bit longer in this environment. That means that the main stock of high-rate auto loans has already expired for most retail banks.

Furthermore, interest rate risk is forward looking for lenders. That is, any long term loan has to be judged against the risk that rates will rise towards the issue rate, leaving you with a low (or negative!) real return.

This is a pretty big deal. Regulators have a big eye for interest rate risk – rightfully so, in my mind – which means that your lending book is hugely constrained. Obviously most banks don’t hold a huge book of 30-year mortgages, but now most 15-year mortgages have to be sold on, which means you’re only getting small revenue streams for loan servicing.

And keep in mind that your core capital ratios are based on your total assets under management. If you only a tiny net interest margin on your loan book, it has big implications for your profitablility.

Fewer people borrowing only compounds the issue. You have a diminishing pool of existing loans, few options for new ones, and little profitability if you do make then. All around a bad situation.

Posted by strawman | Report as abusive

I agree Waldman is very insightful.
What is interesting to me is to look at the comments, which I think exposes inexactness in the article, the idea that low interest are always stimulative.
As well as, who are “rich lenders?”
“And this is Waldman’s thesis about price stability: it helps out rich lenders in bad times, and helps out poor borrowers just when they don’t really need it.”

Is a rich lender an old person with savings, ANY bank or saving and loan, or any entity with access to FED funds? Or is it the big five – JPMorgan, Goldman Sachs, et al? I would say that the FED protects and REWARDS the richest and most imprudent.

Also, I find it laughable after the biggest financial disaster since the Great Depression (and maybe ever – lets see how long this goes)that the FED assures stability. Remeber that the FED existed at the Great Depression, as well as during the era when “subprime was contained.”
And I also suspect that the Jimmie Stewart idea about that low interest rates bad for banks and high interest rates good has gone the way of the buggy whip. A good portion of finance today is funded by the shadow banking system that runs on derivaties and leverage. oric-inversion-shadow-banking

Posted by fresnodan | Report as abusive

The axiom that raising rates slows the economy while lowering them stimulates it does not work at the zero bound. At zero rates of interest what one sees is lower spending and hoarding of savings by the saving class to compensate for lost income and mis-allocations of capital since at a zero rate of interest just about any idea is n.p.v. positive.

Posted by Sechel | Report as abusive

Interesting comments, strawman. Hadn’t thought of the implications of an expected rise in interest rates on the risk of the loan book.

Posted by TFF | Report as abusive

I want to read the entire article and think about it in depth, but here’s one important thing right off the bat: It is not so much that lenders have an interest in _low_ inflation. What they want is _stable_, and predictable, inflation.

If I had a pile of money to lend, and I knew inflation was going to be between 9 and 11 percent for the next 30 years, then there’s no problem: the inflationary expectations are priced right into the loan rate. Conversely, if I lend money expecting zero percent inflation, and inflation instead surges to two percent, that’s still a fairly low value in any absolute sense, but I’m going to lose a lot of money just the same.

Lots of people run together “low inflation” with “stable inflation” in their minds, and there is some reason behind this–very high inflation can set off all kinds of instability, including hyperinflationary spirals. But the concepts are different.

Posted by ckbryant | Report as abusive

This writer does not appear to understand central banks or the economy, as illustrated by this argument:

“So if you’re a rich lender, you’re unhappy in bad times and happy in good times. Far from insuring the rich against bad times, the central bank seems inclined to kick them when they’re down.”

These two sentences indicate either that he is trying to mislead the reader, or that he thinks the “rich lenders” are banks. In reality, the “rich lenders” are persons on a fixed income, in most cases retirees, or, in rare cases, very thifty folks who save their money.

The banks are the biggest DEBTORS in the world. They owe all the depositors, and all their derivative counter parties. When they get the central bank to induce inflation, it become easier for them to repay what they owe. That’s why they want monetary debasement in the form of LTROs, QEs and so on and so forth.

Both big banks and governments hate gold, silver, platinum and any other metal that can serve as a substitute for irredeemable fiat money/ This is because, unlike fiat money, metals cannot be debased in a stealth manner. If you want to debase coinage, you must do it by adding base metals, and this is too obvious to the general population. Under a metals based monetary system, it is harder for a Kleptocratic state to exist and be quietly ruled by and for a small insular elite, such as banks in America and Europe, or industrial oligarchs and/or communists in Russia and China now and in the past.

Posted by ttolstoy | Report as abusive

Also, Waldman seems to pass over the notion of deflation, which is also a risk if no one is looking out for price stability, and which of course is totally brutal for borrowers.

And yeah, the stagflation of the 1970s–remember what it took to get that under control.

Posted by Moopheus | Report as abusive

Seriously, man: “inflation” as defined since the late 1970s means “normal people’s wages.” Central bankers (in the U.S. especially) have, since that time, done whatever they could to tamp down inflation, so defined, while at the same time finding new ways to measure it so that the definition is obscured.

Your larger point is spot-on, of course.

Posted by Eericsonjr | Report as abusive

One nit. There are two bounds monetary policy: the zero bound and the market rate. When we say the Fed is raising rates, we mean it is lowering them less.

The Fed is never helping savers.

Posted by MorgantownJoe | Report as abusive

If former New York Fed Chairman and Goldman Sach’s alumni Stephen Friedman knew about secret loans to Goldman in 2008 and 2009, how did he not buy GS with unknown information? former-new-york-fed-chairman-and.html

FINRA, SEC, DOL, CFPB, FTC, FRB, and PCAOB Wells Fargo Whistleblower Filing ra-sec-dol-cfpb-ftc-frb-and-pcaob.html

Did Warren Buffet know about Bank of America’s Secret Liquidity Lifelines when Berkshire Hathaway Invested $5 Billion in BAC? -warren-buffet-know-about-bank-of.html

Updated with some Warren Buffett and Goldman Sachs: “The Fed’s Secret Liquidity Lifelines”: Wachovia Corporation and Wells Fargo & Company s-secret-liquidity-lifelines.html

Posted by Hartzman | Report as abusive