Tags: McKinnon | Fed | rates | banks

Stanford's McKinnon: Fed Has 'Distorted Financial System'

Wednesday, 31 Jul 2013 08:16 AM

By Dan Weil

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The Federal Reserve and other major central banks have achieved the exact opposite of their goals through massive easing, according to Stanford University economist Ronald McKinnon.

The central banks have constrained economic growth rather than boosted it, he writes in The Wall Street Journal.

"By trying to stimulate aggregate demand and reduce unemployment, central banks have pushed interest rates down too much and inadvertently distorted the financial system in a way that constrains both short- and long-term business investment," McKinnon explains.

Editor's Note:
 
Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

By sending long-term interest rates to historic lows, central banks have generated massive bond market rallies — bubbles, he notes.

"Major industrial economies have all dramatically increased the market value of government and other long-term bonds held by their banks and other financial institutions," McKinnon writes.

"Now each central bank fears long-term rates rising to normal levels, because their nation's commercial banks would suffer big capital losses — in short, they would 'de-capitalize.'"

So what's the solution?

"The way out is for major central banks ... to begin slowly increasing short-term interest rates in a coordinated way to some common modest target level, such as 2 percent," McKinnon contends. And they should phase out quantitative easing, he maintains.

As for what the Fed will do at its September policy meeting, half of the 54 economists surveyed by Bloomberg predict the central bank will cut its monthly bond buying to $65 billion from the current $85 billion rate.

"The markets have adjusted to the new information that the Fed is likely to reduce purchases over the near term, and they've come to terms with it," Russell Price, senior economist at Ameriprise Financial, told the news service.

"Investors believe it won't be a strong negative for the markets or the economy."

Editor's Note: Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

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