In response to todayís column, Iím getting a lot of the usual: namely, the claim that low interest rates donít prove anything, because the Fed has been buying up all the federal governmentís debt issue. This is always said with an air of great wisdom; in fact, itís remarkably foolish, managing to be wrong in three distinct ways.
First of all, it isnít true that the Fed has consistently been buying a lot of Federal debt issue. Sometimes it has, sometimes it hasnít; when QE2 stopped, there were widespread predictions that interest rates would spike, but they didnít ó as those of us who have been getting it right predicted.
Second, the idea is conceptually wrong. Asset prices should be determined mainly by the stocks of assets, not the changes in these stocks over short periods. If bond investors lose confidence in federal debt, thereís a huge outstanding stock of that debt for them to try to sell, driving rates up, no matter how much of the new issue the Fed might be buying.
But maybe the killer is this: since when do the kinds of people who worry all the time about deficits believe that the Fed can monetize a substantial part of a large deficit, for four whole years, without any negative consequences? If you believed in the framework these people have, all that expansion of the monetary base should have produced runaway inflation by now, as many of them did in fact predict early in the game. It hasnít ó and no, donít give me the bit about the government hiding the true rate of inflation. Independent estimates are not significantly different from the official gauges. Now, back in late 2008, contemplating the situation we were in, those of us who saw it in terms of basic IS-LM macro made a twofold prediction: as long as the economy stayed depressed, interest rates and inflation would both stay subdued despite both large deficits and a huge expansion of the Fedís balance sheet. There was much scorn for that prediction at the time; how do you think it has looked since?