Joseph Stiglitz on Trump

In the new world wrought by President Donald Trump, where one shock follows another, there is never time to think through fully the implications of the events with which we are bombarded.

In late July, the Federal Reserve Board reversed its policy of returning interest rates to more normal levels, after a decade of ultra-low rates in the wake of the Great Recession. 

Then, the United States had another two mass gun killings in under 24 hours, bringing the total for the year to 255 — more than one a day. And a trade war with China, which Trump had tweeted would be “good, and easy to win,” entered a new, more dangerous phase, rattling markets and posing the threat of a new cold war.

At one level, the Fed move was of little import: a 25-basis-point change will have little consequence. The idea that the Fed could fine-tune the economy by carefully timed changes in interest rates should by now have long been discredited—even if it provides entertainment for Fed watchers and employment for financial journalists.

Not a lack of liquidity

If lowering the interest rate from 5.25% to essentially zero had little impact on the economy in 2008-09, why should we think that lowering rates by 0.25% will have any observable effect? Large corporations are still sitting on hoards of cash: it’s not a lack of liquidity that’s stopping them from investing.

Long ago, John Maynard Keynes recognized that while a sudden tightening of monetary policy, restricting the availability of credit, could slow the economy, the effects of loosening policy when the economy is weak can be minimal.

Even employing new instruments such as quantitative easing can have little effect, as Europe has learned. In fact, the negative interest rates being tried by several countries may, perversely, weaken the economy as a result of unfavorable effects on bank balance sheets and thus lending.

The lower interest rates do lead to a lower exchange rate BUXX, -0.01%  . Indeed, this may be the principal channel through which Fed policy works today.

But isn’t that nothing more than “competitive devaluation,” for which the Trump administration roundly criticizes China? And that, predictably, has been followed by other countries lowering their exchange rate, implying that any benefit to the U.S. economy through the exchange-rate effect will be short-lived.

More ironic is the fact that the recent decline in China’s exchange rate USDCNH, +0.0396%  came about because of the new round of American protectionism and because China stopped interfering with the exchange rate — that is, stopped supporting it.