The single most important price in all of capitalism is the interest rate—-and at all points on the maturity curve. And the single most important truth about honest interest rates is that they must be discovered by markets, not imposed by the state.
We got to ruminating about those core propositions when we read that San Francisco Fed head, John Williams, may be headed toward the true #2 job at the Fed. That is, President of the New York Fed—-the joint that actually runs the casinos domiciled in the canyons of Wall Street.
We did not burst out laughing exactly, but nearly so. After all, why do you even need Wall Street if you are going to have John Williams running the joint?
Recall that Dr. Williams claims to see a financial apparition that no one has ever touched, measured, photographed, X-rayed or otherwise proven the existence of. We are referring, of course, to the “Neutral Rate of Interest”.
By contrast, Dr. Williams is certain that he has spotted it, measured it and completely understood it. Indeed, he is so certain that in recent times it has been extraordinarily low, that he wants to run the entire $19.7 trillion US economy on the basis of it.
That is, peg actual interest rates in the money market based on a theoretical rate that might as well be the equivalent of a Monetary Unicorn. That’s because no one on the bond and bill trading desks of Wall Street has ever seen it, or ever will.
Not only that, but Dr. Williams now suggests that we actually need even more inflation than the sacred 2.00% target to cure whatever ails the US economy, and that his Monetary Unicorn told him so. Thus, as per the AM’s Wall Street Journal:
His influential research at the Fed includes his work with Thomas Laubach, a top Fed economist, on identifying the neutral rate of interest: the inflation-adjusted rate that neither spurs nor curbs growth. Understanding how to glean this unobservable rate is critical to setting Fed interest-rate policy.
Mr. Williams has argued, and many other officials have come to agree, that the neutral rate fell very low during the financial crisis and recession and hasn’t recovered much since. This conclusion became a key factor behind the Fed’s thinking in keeping its own benchmark federal-funds rate very low in recent years and then raising it slowly and cautiously.
More recently, Mr. Williams has been outspoken in calling on Fed officials to rethink their 2% inflation target, and allow periods where inflation might run higher to make up for times where it runs lower.