A recent post by Arnold Kling contained this passage from an interview of Robert Hall:
even though the Fed has driven the interest rate that it controls to zero, it hasn’t had that much effect on reducing borrowing costs to individuals and businesses. The result is it hasn’t transmitted the stimulus to where stimulus is needed, namely, private spending.
Immediately after the quotation, Arnold had this to say:
The spread between the interest rates on private debt and the interest rates on Treasuries shot up during the crisis. Hall calls this an increase in “friction.” Many of us instead call it an increase in the risk premium. Whatever one calls it, it is an important phenomenon. No matter how hard he tries, Scott Sumner just cannot convince me that this phenomenon is due to a drop in expectations for nominal GDP growth.
Perhaps I am reading too much into this juxtaposition of comments, but it seems to me that Kling is implying that Hall’s views of the crisis are different from mine. Just to be clear, I think that credit markets did freeze up in late 2008, and that that hurt the real economy. But I also think the Fed could have greatly reduced the severity of the financial crisis. And I am pretty sure that Hall agrees with me. Here is Robert Hall and Susan Woodward:
Raising the reserve interest rate is a contractionary measure. A higher interest rate on reserves makes banks more likely to hold reserves rather than increasing lending. The Fed’s decision to raise the reserve rate from zero to 75 basis points just as the economy entered a sharp contraction in activity is utterly inexplicable. Fortunately, the Fed lowered the reserve rate subsequently, but the continuation of a positive reserve rate in today’s economy is equally inexplicable. Some economists have proposed that the Fed charge banks for holding reserves, an expansionary policy worth considering. With the Fed funds rate at around 15 basis points, it would take a charge to restore the differential that drives banks to lend rather than hold reserves. Were the Fed to charge for reserves, they would become the hot potatoes that they were in the past, when the reserve rate was zero and the Fed funds rate 4 or 5 percent. Banks would expand lending to try not to hold the hot potatoes and the economy would expand. There is no basis for the claim that the Fed has lost its ability to steer the economy. (However, the Fed would have to go to Congress to get this power, as it did to get the power to pay positive interest on reserves.)
Isn’t that precisely my view of the crisis?
1. Interest on reserves was a big mistake and still is.
2. If anything the rate should have been negative.
3. The Fed did not lose it’s ability to steer the economy when rates hit zero.
I think the third point implies that if we aren’t happy with the ditch into which the economy has been “steered,” we should take a hard look at what the Fed has or has not been doing.