Thursday, July 25, 2013

Is The Fed's Policy Of Paying 0.25% Interest On Bank Reserves Harming The Economy?

Martin Feldstein argued that the Fed is responsible for many of our economic problems because it is paying banks interest on the reserves that it holds.  Noah Smith tore this argument apart and Paul Krugman went into more detail about why Feldstein is wrong.  He ended his post by asking why prominent economists like Feldstein keep making bad arguments that are not supported by data, or by economic theory.  I think he knows the answer.  Feldstein was an economic adviser to Ronald Reagan and he has been one of the most important Republican economists in America over the last 30 years.  He was the Chairman of the economics department at Harvard that he staffed with influential economists who share his political philosophy.  He was also the head of the National Bureau of Economic Research (NBER) where his influence is still present.  Most economic problems are very complex and they are very hard to untangle.  Clever economists like Feldstein are expert at shaping the data to fit their desired conclusions.  Government is usually the problem rather than the solution.  The ideal world is one in which markets are permitted to operate without government interference.  For example, at a recent session of the NBER, that honored Martin Feldstein, a paper was presented that concluded that the rapid rise in CEO compensation was best explained by the operation of the labor market.  Corporate boards are forced to pay what the market for CEO's has determined.  The price is always right.  Greg Mankiw, who is the current Chairman of the economics department at Harvard makes a similar argument.  The rapid rise in CEO compensation is explained by market forces.  The wage premium reflects a rapid increase in their productivity.

Keynes provided an answer to Krugman's question many years ago.  He argued that David Ricardo's influence within the economics profession was best explained by the coincidence of his theoretical framework with the interests of the powerful in British society. 

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