Harvard professor Larry Summers has blasted an op-ed article that appeared in The Wall Street Journal on Tuesday criticizing the Federal Reserve.
Writing on his blog late Wednesday, Summers said a piece from Michael Spence and Kevin Warsh asserting that Fed policy had weighed on corporate investment was simply nonsense.
“My friends Mike Spence and Kevin Warsh, writing in yesterday’s Wall Street Journal, have produced what seems to me the single most confused analysis of US monetary policy that I have read this year,” Summers wrote.
“Unless I am missing something – which is certainly possible – they make a variety of assertions that are usually exposed as fallacy in introductory economics classes.”
Spence won the 2001 Nobel Memorial Prize in Economics, and Warsh is a former Fed governor.
- REUTERS/Hyungwon Kang
Neither the Journal article nor Summers’ response addressed the Fed’s decision on Wednesday to keep interest rates pegged near 0%. The Fed’s announcement, however, did explicitly mention what it would need to see to raise interest rates at its December meeting. The Fed has kept rates near 0% since December 2008 and hasn’t raised rates since July 2006.
Spence and Warsh say the Fed’s quantitative-easing program – which involved the outright purchase of Treasury bonds and mortgage-backed securities – effectively created less uncertainty in financial markets.
In their piece, Spence and Warsh wrote, “We believe that QE has redirected capital from the real domestic economy to financial assets at home and abroad.”
The critique asserts that quantitative easing did nothing to dampen uncertainty in the “real” economy. As a result, they argue, corporate decision makers balked at spending money on things like employees or equipment, given the unknown consequences of this program.
In Spence and Warsh’s view, this uncertainty has led to the increase in share buybacks that have been roundly criticized as “financial engineering” by critics on both sides of the economics divide.
Standard economic thinking, as Summers hints toward, would say that lower interest rates encourage companies to spend money on things like equipment and labor not only because it is less expensive to borrow money, but because saving money earns you nothing.
In other words, low rates are supposed to encourage companies to do something with their cash.Buying back shares, however, is an investment in your company, if not one that really does anything for people other than your shareholders. But recall again, however, that Spence and Warsh think QE is hurting the “real” economy, not the financial one (which is what buybacks are investing in, more or less).
Typically, as Summers notes, critiques of Fed policy center on concerns about runaway inflation (which have proved unfounded to this point), or financial stability. And while Summers disagrees with these attacks, they are at least the sort of accepted way one goes about bashing the Fed.
And so as Summers writes, Spench and Warsh “assert a proposition that I have not encountered in 40 years as a professional economist – that overly easy monetary policy reduces business investment.”
The short of it, then, is that Summers doesn’t understand where Spence and Warsh get their evidence from, writing, “For now though I would put the Spence-Warsh doctrine that easy money reduces investment in a class of propositions backed by neither logic nor evidence.”