Not long ago, there lived an American economist who thought that it would be best to close down the Federal Reserve, the US central bank. A rather drastic view. What makes it particularly interesting is that it wasn’t voiced by some extremist, sidelined, unrecognised scholar. On the contrary. This view was held by Milton Friedman, one of the most influential economists that ever lived, a Nobel Prize winner economic counsellor to President Reagan.
Despite a zero interest rate the threat of falling prices is imminent, which hurts the economy rather badly. In a famous 2002 speech, former Fed chair Ben Bernanke proposed a conceptual solution to this very situation: as the printing press is a monopoly of the state, newly printed money should be injected into the economy, which will prevent deflation. Later on he also had the opportunity to do the stunt in practice.
I have a problem with the concept of a monetary system driven by interest rates. My problem is that it will work well only in a certain range of the parameters describing the state of the economy. Interest rates may only be an efficient means of influencing inflation where debt, foreign currency debt, wealth inequality, etc. are not excessively high, but people’s expectations for future inflation also make a difference. That’s what I call the working range of the system. Outside that range, risks and side effects will increase radically.
Recently there’s been a lot of talk about the excessive indebtedness of the world and the need to deleverage. However, debt is the mirror image of savings; that’s what our monetary system is built upon. If debt has become too high, this also means that the amount of savings has reached an unsustainable level too. The landslide hitting the world economy in 2007/2008 is termed ‘credit crisis’, while it could reasonably be called a savings crisis as well.
In April 1986 an experiment was performed in a Soviet nuclear power station. We all know what happened next: the experiment went wrong and the most serious nuclear accident to date ensued. As tends to be the case, the unfortunate development of several independent factors played a role in the disaster occurring. It was a combination of conspiring factors.