Dean Baker, Mason, DeLong, Krugman: bankers: evil or stupid

The Argument for Higher Interest Rates: Are the Bankers Evil or Stupid? by Dean Baker

I see my friends Paul Krugman and Brad DeLong are arguing over whether the pressure from the banking industry for the Fed to raise interest rates is the result of their calculation that higher interest rates would raise their profits or is it just ignorance of the way the economy works. Krugman argues the former and DeLong the latter. I would mostly agree with Krugman, but for a slightly different reason.

I don't see the clear link, claimed by Krugman, between higher Fed interest rates and higher net lending margins for banks (the difference between the interest rate they charge on loans and the interest rate they pay on deposits). Such a link may exist, but his data don't show it. On the other hand, I think it is still not hard to make a case for banks' self-interest in following a tight money policy.

An unexpected rise in the inflation rate is clearly harmful to banks' bottom line. This will lead to a rise in long-term interest rates and loss in the value of their outstanding debt. This is very bad news for them.

While we (the three of us) can agree that such a jump in inflation is highly unlikely in the current economic situation, it is not zero. Furthermore, a stronger economy increases this risk. If we assume that the banks care little about lower unemployment (they may not be bothered by lower unemployment, but high unemployment is not something they wake up every morning worrying about), then they are faced with a trade-off between a greater risk of something they really fear and something to which they are largely indifferent. It shouldn't be surprising that they want to the Fed to act to ensure the event they really fear (higher inflation) does not happen. Hence the push to raise interest rates.

I suspect also there is a strong desire to head off any idea that the government can shape the economy in important ways. There is enormous value for the rich to believe that they got where they are through their talent and hard work and that those facing difficult economic times lack these qualities. It makes for a much more troubling world view to suggest that tens of millions of people might be struggling because of bad fiscal policy from the government and inept monetary policy by the Fed.

Interest Rates and Bank Spreads by J.W. Mason