So What Exactly Was Robinson’s “Cheap Money Policy”?

In my last post, I quoted Joan Robinson, the renowned Cambridge University economist, on the determinants of long-term interest rates. The mention of Robinson was made in the context of a comment on the Fed open market committee meeting earlier this week and Chairman Ben Bernanke’s press conference on Wednesday. For those who might be curious, here is the “cheap money” scenario from Robinson that I mentioned in the earlier post; astute readers will notice parallels in recent Fed history:

The first move in the campaign is for the Central Bank to dose the banks with cash, by open market purchases. The amount of advances the banks can make is limited by the demand from good borrowers. The demand is very inelastic (though it shifts violently up and down with the state of trade), so the banks, between whom competition is highly imperfect, see no advantage in cheapening their price. The redundant cash reserve must go into bills. Any rate of return is better than none. The banks with redundant cash find themselves in much the same position as a group of firms with surplus capacity and zero prime costs. If perfect competition prevailed, the bill rate would go to next to nothing and the banks could not cover their costs. They therefore fix up a gentlemen’s agreement which keeps the bill rate steady at a low level. The bill rate is maintained at this low level by the Central Banks giving another dose of cash whenever it threatens to rise.

If the Central Bank is operating in the old orthodox manner, its power ends here, and the authorities must rely on the dealers in credit to bring the long rates down. Nowadays the authorities reinforce the action of the banking system by going into the bond market directly. If necessary, they issue bills in order to buy bonds, the quantity of money being adjusted to whatever level is required to keep the bill rate at its bottom stop. The low interest rates may slow down the velocity of active circulation so that money, as the saying is, stagnates in pools. Long hoards are swollen by the fall in current rates and bear hoards by the fact that expected future rates are not yet revised.

As time goes by, experience of a long rate that is persistently somewhat lower than the expected rate lowers the expected rate and so lowers the actual rate further. The yield on shares falls in sympathy with the bond rate. Thus the whole complex of rates gradually falls through time. If the authorities take it gently and do now try to push the rate down too fast, and if they stick consistently to the policy, once begun, so that the market never has the experience of today’s rate being higher than yesterday’s, it is hard to discern any limit to the possible fall in interest rates (except the mere technical costs of dealing) so long as the full-employment interest rate is below the actual level of rates or is held below it by a budget surplus or other means.

Joan Robinson, in “The Rate of Interest” (1951) from The Generalization of the General Theory and Other Essays, published by St. Martin’s Press, New York, 1979, pages 163–64. (The date of the original article was stated as 1952 in my earlier post; that is the publication date of the first edition of the book, which appeared under the title The Rate of Interest and Other Essays. My apologies for any inconvenience caused by this error.)