Interest Rates: When Zero Is Way Too High
businessweek.com
businessweek.com
Many will lose homes but consider that, without that "bad" loan, they would have been renting instead. Now suppose we consider all payments they have made as a form of rent - then their situation doesn't look so bleak. Instead of paying off interest on a big loan, they were instead paying rent for a place more luxurious than they could otherwise afford. Not a bad deal really, but one whose time has ended.
The honest bunch of us must tolerate this crappy economic environment simply because politicians fear the phrase "losing their homes". Maybe Lakoff is correct - the secret to control is framing the debate.
Mark to market is why the institutions that went under already went under. They were cash positive, but couldn't meet their reserve requirements when the markets for their assets disappeared.
Mark to market is absurd for illiquid assets. The fact that I can't sell my house today doesn't mean that it's worth $0.
For illiquid assets, honest valuation involves time averaging. (This cuts both ways - the value doesn't jump just because a fool overpaid for a comparable asset.) And yes, some penalty for illiquidity.
Yes, and more will have to disappear to resolve this situation. The sooner the better.
>Mark to market is absurd for illiquid assets. The fact that I can't sell my house today doesn't mean that it's worth $0.
Unfortunately it means precisely that. The home is worth $0 (or less) when offered for sale on the market.
Don't confuse the market's valuation with some other personal valuation of "worth".
Long-term investors holding cash may justify their purchases by using time-averaging, but they are very rare and getting their attention is difficult unless you have 100s if not 1000s of homes to sell in blocks.
Inflation, and a weaker dollar would also help import/export imbalances. A weaker currency would help the US, and hurt outside investors.
I think it's all but inevitable.
Now, you can fight off the short term effects of recession, and it's typically popular politically. But there's some real ramifications. Here's how it probably goes:
Causing inflation is extremely likely to weaken the dollar, which hits first and foremost the people making the lowest real wages. The people making the lowest real wages have little power to strike or collectively bargain that organized or semi-skilled labor has, little to no control over pricing like professionals have, and no places to invest money in real assets to shelter money from inflation. The poor get screwed the hardest in this whole inflationary gig, on the money supply of things.
When quality of life drops in America, especially for the most poor of people, then the government needs to decide to try to counteract that. They do this by increasing subsidies and welfare. If these programs are large enough to counteract the heavy inflation, they're quite expensive. Ironically, this further increases inflation, and leads to either (1) a weaker U.S. dollar, or (2) higher taxes, or (3) both.
In the case of a weaker dollar, you've now changed currency trading and interaction across the entire global economy. China and Japan are both looking at much stronger currencies vis-a-vis the dollar than in recent years, which sets off all sorts of unplanned chains of events.
As for taxes - most people dislike being taxed simply by virtue of having less money and things. As far as I can tell, most people don't like paying taxes and instead prefer to keep their money. However, raising taxes while simultaneously intentionally raising inflation has a particularly interesting outcome: Money and capital flow out of your country really fast.
Why? Due to inflation, people don't want to carry your currency or bonds. The value of the currency/bonds is going to be worth less next year than today, so you need to move it to an asset that you expect to increase in value or hold its value - a commodity, equity, or real estate perhaps.
Now, due to higher taxes, people have less risk tolerance. This is because typically (unless you're a bank, or in good with Washington) government doesn't pay you if your business fails, and does tax you if you succeed. That means that people invest less. Which normally might mean people holding cash reserves while looking for a change, but during inflation - people need to put the money somewhere, or else it'd get inflated away and you'd have less at the end of the year.
End result? Because people will seek to invest their capital (due to inflation), but be less inclined to do it in the USA (due to taxes), you get less long term investment in American industry. That means less long term employment created, less machinery bought, less real estate developed. Money that would get invested in Nebraska gets invested in Chengdu, or Goa, or Sophia.
Now, I'm a global sort of guy, and I happen to quite like Chinese people, and Bulgarians seem quite cool to me, and I hear Goa's a great place. So it's not a net loss for the world. But it does seem like a curious policy for the U.S. government to pursue.
It's especially ugly for for the poorest people who have the least control over their wages. And in a brutal double-edged fashion, Chinese, Indian, and Bulgarian industries become more efficient and cheaper which further causes less demand for American-made goods. The result? Greater unemployment. Which further depresses wages.
Messing with the money supply right now might suit some special interests (maybe like a bank with lots of bad debt on their books, that's holding assets that have crashed from an artificial high, that needs to liquidate those assets in order to pay obligations while nearing insolvency... hmm...). But it doesn't seem to serve the poor, the middle class, or the wealthy Americans very well.
Historically, inflation has not hit the lowest paid the hardest. That's because inflation causes a reasonably uniform increase in prices, which includes the price of labour. It may be that the weakening of unions means that this effect will not occur this time, but a fall in the value of the currency suggests that prices should rise across the board, so this should be our working assumption. Usually, inflation is a transfer of wealth from those with savings to those with debts. It could conceivably help the worst off. In comparison, deflation will certainly lead to mass unemployment and will hurt the poor very badly, especailly those with debts.
You say that inflation will lead to higher welfare costs, but deflation will lead to far higher welfare costs due to mass bankruptcy and unemployment.
Furthermore, deflation increases the real value of government debt, and the depression caused by it will destroy tax revenues. This results in a higher risk of soverign default, which potentially causes a run on the currency.
In fact, almost all of the problems caused by inflation will also occur with deflation, only they will be far more severe. So that's why it makes sense for the Fed to pursue this policy. It has bad consequences, but they are minute in comparison to the deadly consequences of deflation and mass institutional failure.
If dollars were to rise in value, it would constitute a transfer of wealth away from people with debts and towards people with cash savings. The first effect is that people will no longer be able to service the increasing real value of the interest on their debts, leading to default.
But the more serious secondary effect is that a rising dollar encourages people to hoard money rather than spending it, as dollars tomorrow will be worth more than dollars today. The result is a liquidity crisis, where everyone refuses to consume or invest. The liquidity squeeze makes dollars even more valuable, and so the effect is self-perpetuating, until eventually the economy grinds to a halt.
The worst historical example of deflation is the Great Depression, where local communities were having to invent their own currencies to make up for the extreme dollar shortage. The Great Depression is the reason central banks have positive inflation targets. Although inflation is bad, a small amount of inflation is a fair price if it reduces the risk of self-perpetuating deflation.
The situation should not be such that most people are in debt. People with wealth are free; those in debt, not so much.
> a rising dollar encourages people to hoard money rather than spending it
This is also referred to as conservation, frugality, delayed gratification, and saving for a rainy day. Placing value on the future is generally regarded as a good thing.
The effects of deflation really are terrible. Look at the tech sector where Moore's law assures that prices on computers are always dropping. I don't think I know anybody who owns a computer - everybody is waiting for them to get cheaper before buying.
If one person hoards dollars, they are being frugal. If everyone increases their liquidity preference, real wealth is destroyed. The gratification is not delayed, but lost forever. You are committing the fallacy of composition.
Moore's law is not deflation. Deflation is a persistent rise in the general price level, as measured using a representative basket of goods.
Have you never delayed buying a new console because you knew the price would drop soon? I have.
Actually, it is. Moore's law implies a continuous decline in the prices of computers.
Deflation is a persistent rise
Decline.
in the general price level as measured using a representative basket of goods
The defined goods area can be broad or specific, and in any direction. There has been consistent deflation, for the past several decades, in the area of computer products. Individuals and groups (companies, etc.) that tend to value computer products highly also tend to delay their purchases of those computer products in anticipation of price declines, i.e. deflationary action.
If you're going to define deflation as a fall in the price of any basket of goods, then you're just using it to mean 'the price of something went down'. You can do that if you want, but it's hardly helping the conversation.
That would be the same thing as a rise in the value of money.
You can [flexibly define things narrowly or broadly] if you want, but it's hardly helping the conversation.
Do you use a different word for "temperature" for the temperature in your home, because some other parties use the word "temperature" to mean "gobal temperature"?
Different economic actors will value different things at different rates. Economic actors that happen to value computers highly will indeed perceive a rise in the value of money when computer prices drop.
And the term "general" is also defined. It can mean general within a nation. It can mean general worldwide. It can mean general on a continent. It can mean general in a state. It can mean general in an economic sector (food, computers, cars, clothes, houses, etc.). Etc.
So, we have to use a different word to describe non-general price declines? If so, what word would you suggest? http://www.google.com/search?q=deflation+prices+computers
Why would it be OK to use the word "temperature" in different contexts, but not the word "deflation"? What about the word "pressure"? Should we use a different word for tire pressure, because of the fact that "pressure" is also used in other contexts?
> what word would you suggest?
How about 'falling prices'?
>And the term "general" is also defined.
Now you're just trolling.
> How about 'falling prices'?
You are going to have to go after a lot of people and criminally prosecute them for illegally using the term "deflation" instead of the legal term "falling prices". http://www.google.com/search?q=deflation+prices+housing There are over 2 million Google hits for housing-price deflation, alone.
There is also a general temperature of my home. The general temperature of my fridge contributes to that. In turn, the general temperature of the top shelf of my fridge contributes to the general temperature of my fridge.
From what it would be if they got to borrow money for free, yes. However, their future wealth is still higher than it would be if they didn't take the loan in the first place and therefore could not generate that income. Of course the creditor expects more "real value" back than he loaned out - he wouldn't be in business very long otherwise.
> If everyone increases their liquidity preference, real wealth is destroyed
Nothing is destroyed, production has been delayed. Natural resources stay in the ground and people enjoy time off, rather than being forced to work full time just to dump their excess income into nondurable goods. Unless your goal is to strip mine the planet as fast as possible, these are good things.
> Have you never delayed buying a new console because you knew the price would drop soon? I have.
Precisely! My point about electronics is that people delay purchases, but don't stop altogether. Cautious purchasing based on real costs is healthy; the cheap-money fueled consumerism bubble of the past decade is not.
> Natural resources stay in the ground and people enjoy time off
Unemployment is not time off, nor is it delayed gratification.
> My point about electronics is that people delay purchases, but don't stop altogether
Yes, they delay their purchases, causing a contraction of the economy that creates real suffering, hence a loss of wealth that otherwise could have existed. Consequently most of the purchases never happen, and are therefore not 'delayed' but lost.
> Prudence is healthy; instant gratification consumerism is not.
It is prudent for the individual and destructive to total economic output. Are you trying to deny that recessions reduce people's wealth?
> Unemployment is not time off
If one has wealth saved up, then what is the problem? When people don't need their jobs, it creates a much healthier employer-employee relationship. How many entrepreneurs start off in personal debt?
> nor is it delayed gratification.
Maybe it's just me, but I'd rather have more minerals in the ground, and less discarded crap in the landfill. I've got no problem depleting natural resources, but forcibly driving this process through overstimulating the economy is needlessly screwing over future generations.
> causing a contraction of the economy that creates real suffering
I hate being hungover too. But man, that party was killer! If your problem is withdrawal, the solution is to avoid engaging in the first place.
> destructive to total economic output
I suppose it's pointless to argue with someone who thinks the ultimate goal is to maximize "total economic output". Let's pass laws mandating that everybody must work 16 hours a day!
Technology should be making it so we work ever less. Instead, the excess wealth is siphoned off to the bankers and government, precisely through the inflationary sleight of hand that you are advocating.
But remember, deflation is scary; why should the plebs ever see the benefits of technology?
I'm not pandering to anyone. I'm pointing out that deflation is a transfer of wealth. I'm not judging it, just pointing out the economic fact.
> If one has wealth saved up, then what is the problem?
If you don't care about being unemployed then that's fine. All power to you. But most people do care.
> forcibly driving this process through overstimulating the economy is needlessly screwing over future generations.
Recessions do not increase people's overall savings. They force people into bankruptcy and reduce total wealth, now and in the future. Recessions screw over future generations.
> If your problem is withdrawal, the solution is to avoid engaging in the first place.
Almost everyone suffers in a recession, not just the people who caused it.
> Let's pass laws mandating that everybody must work 16 hours a day!
That would be a reduction in wealth, as people would be forced to make economic decisions they otherwise wouldn't. I would never support it.
> Instead, the excess wealth is siphoned off to the bankers and government, precisely through the inflationary sleight of hand that you are advocating.
This is just conspiracy theory nonsense.
And I'm not advocating inflation. I'm advocating a stable price level, the kind that has enabled the economic growth that has lifted millions of people out of poverty over the last decade. Inflation and deflation are both bad. However, if we are forced to choose one or the other, it is better to choose inflation.
Because they live paycheck to paycheck, with perhaps a finite safety net on which to make their debt payments. The need of people to be productive is another topic, which doesn't necessarily need to be (and sometimes isn't even) fulfilled by full time day job.
> They [recessions] force people into bankruptcy and reduce total wealth, now and in the future
Yes, which is why I'd like to stop the inflationary bubble policy. Remember the dot com bust? And then 2004? Our current problems stem from patching those up by permanently lowering interest rates. Further lowering them now will just cause another bubble that will burst in several years.
> Almost everyone suffers in a recession, not just the people who caused it.
Yes, but as we're talking about monetary policy, we're talking about the people who caused it.
> That would be a reduction in wealth, as people would be forced to make economic decisions they otherwise wouldn't.
Well if you've got a problem with the "forcing", then how about just government subsidies of 5x salary to those who work 16 hours a day? Flooding the market with cheap money is the same kind of manipulation which causes people to make economic decisions they otherwise wouldn't.
> This is just conspiracy theory nonsense.
I'm not saying they meet up an plan this, or even do it consciously, but there most certainly is a parasitic economy that receives all of the newly introduced money first, and therefore gets its benefits before the effects of the inflation are felt. Furthermore, the wealthy are able to hire "asset managers" to help them avoid the inflation, while the little guys have their savings eroded.
> I'm advocating a stable price level ... However, if we are forced to choose one or the other, it is better to choose inflation.
And if you haven't noticed, prices aren't anywhere near stable, but are generally on the rise. One can't claim to be for "stable prices" but also be against any possible drop. There will always be fluctuations, so suppressing any downwards movement will always produce a net upwards trend, not stability.
But the main problem is that technology disagrees. To maintain a stable price index while technologically influenced goods are dropping requires everything else to go up. When efficiency is increasing, why should prices be stable?
> which is why I'd like to stop the inflationary bubble policy
The current monetary policy of all the Western governments is inflation targeting (with the exception of the US, which uses a triple mandate, of which inflation targeting is the most important part). The intention of inflation targeting is to act as an anti-cyclical force in the naturally pro-cyclical credit markets. Left to their own devices, financial institutions would increase credit levels in good times and decrease them in bad times, producing a succession of bubbles and busts. Monetary policy acts against this by pushing up interest rates when it believes there is too much credit and pushing them down when there is too little. It's barometer of whether credit levels are too high or too low is some chosen measure of consumer inflation. In this way, monetary policy reduces the inherently boom/bust nature of financial markets.
There is no 'inflationary bubble policy'. The markets themselves have an inherent tendency towards bubbles. They have existed since the beginning of modern financial markets, long before the current monetary policies were put in place. The claim that central banks inadvertently caused the dot com crash, or other bubbles, is a hotly contested subject in economics. It is not at all certain that it's true, and in any case is something that requires years of study and masses of evidence to resolve. What is certain, however, is that there is no policy of producing bubbles or inflation. The policy is to prevent it. In terms of stabilising consumer prices, inflation targeting has been one of the most successful monetary policies in all history, and the economic growth that has been part of the Great Moderation has lifted millions of people across the world out of poverty. In fact, more people have been lifted out of poverty under inflation targeting than under any other period of stability in history.
> Well if you've got a problem with the "forcing", then how about just government subsidies of 5x salary to those who work 16 hours a day?
How would they pay for it? Presumably by allocating resources from elsewhere, producing no net benefit.
> Flooding the market with cheap money is the same kind of manipulation
Central banks do not flood the market with cheap money. Inflation targeting is a policy whereby the market determines the quantity of money in the economy, and the central bank sets interest rates to encourage or choke off demand for credit. The result is stable consumer prices, at which the central banks have been uncannily successful.
> there most certainly is a parasitic economy that receives all of the newly introduced money first
Money is created through bank loans. The banks and the government do not receive the money first. The person who borrows is the first recipient. If the total amount of credit in a day grows, then the central bank will have to increase the quantity of base money through the purchase of bonds. If it shrinks, then it will sell bonds to reduce the quantity. The first people to see this money are therefore people who trade in the bond market, not banks and not governments. As far as I am aware, there is no evidence that bond traders profit unduly from this. The central bank simply operates as another trader in the market.
> Furthermore, the wealthy are able to hire "asset managers" to help them avoid the inflation, while the little guys have their savings eroded.
This is one of the many reasons why inflation is a bad thing. I agree that inflation is bad. That's why I support inflation targeting. Its raison d'être is to prevent inflation and deflation. It is incredibly good at it.
> To maintain a stable price index while technologically influenced goods are dropping requires everything else to go up.
If the quantity and demand for money and the number of products on the market were fixed, then the decrease in the nominal price of one good would necessarily cause an increase in the nominal price of others. Even if every good were being produced at lower real cost (i.e. with less labour, material and capital input) the 'average' nominal cost of products would stay the same. So you are right, the price of other goods has to go up. That's not a consequence of inflation targeting, but a standard economic result about nominal prices.
And when management asks that you work 10 extra hours a week for the same amount of pay? You're in a much better position if you have several months of living expenses to painlessly tap into.
> Monetary policy acts against this by pushing up interest rates when it believes there is too much credit and pushing them down when there is too little.
Well they're certainly avoiding the whole "pushing up" part. If they were smoothing the cycles out in a sustainable manner, we wouldn't be talking about negative interest rates. Instead, they lower interest rates and keep them there because economic reality is politically inconvenient.
> In fact, more people have been lifted out of poverty under inflation targeting than under any other period of stability in history
How much of this can be attributed to natural technological progress rather than economic planning? And what percentage of the excess wealth (compared to an undriven economy) has been actually used to raise people out of poverty? It's not sustainable progress to get the masses out of poverty if you've used up most of the natural resources in the process.
> Money is created through bank loans. The banks and the government do not receive the money first. The person who borrows is the first recipient.
The person who borrowed is the second recipient, the bank takes the first cut through fees and increased interest. The government gets to tap into the supply through perpetual deficit spending.
> If the quantity and demand for money and the number of products on the market were fixed, then the decrease in the nominal price of one good would necessarily cause an increase in the nominal price of others
But the average (index) remains constant only if you ignore the option to save money for the future, and assume that everything earned must be immediately spent (which is precisely what were debating). When prices go down, total amount of money spent on goods should go down. This money will be saved to give one security and mobility. The price of labor should then rise, and people should be working less. Instead, the savings are eroded through inflation, and workers are kept on a constant treadmill.
What I really have to ask, if these central banks are really doing the optimal benevolent thing, then why do they violently shut down competition? Surely the currency they "stabilized" should win out in the market over possible competitors.
What? I completely fail too see what your point is here. Why would my management ask me to work 10 extra hours a week? What does that have to do with deflation?
> Well they're certainly avoiding the whole "pushing up" part.
How come rates go up then? What evidence do you have that they're 'avoiding' the pushing up of rates? Where is all the consumer inflation that they are allegedly creating?
> If they were smoothing the cycles out in a sustainable manner, we wouldn't be talking about negative interest rates.
Yes they would, because we are entering a potential depression. Smoothing out means cutting when things are bad and increasing when things are good. You have to act at both ends to achieve stable prices.
> Instead, they lower interest rates and keep them there because economic reality is politically inconvenient.
You are very good at making outlandish claims and not so good at backing them up. What evidence do you have that central banks have departed from their mandated inflation targeting regime?
> How much of this can be attributed to natural technological progress
Almost all of it, but technological progress cannot happen without a stable economy. People don't build factories unless they believe they can realise a steady income.
> And what percentage of the excess wealth (compared to an undriven economy) has been actually used to raise people out of poverty?
We do not live in a driven economy. We live in an economy where the value of money is kept stable in order to counteract the economy's natural tendency towards boom and bust. What do you mean when you say the economy is 'driven'? Give an actual economic definition of this term.
> It's not sustainable progress to get the masses out of poverty if you've used up most of the natural resources in the process.
Sustainability is entirely orthogonal to monetary policy. Neither have any affect on each other,
> The person who borrowed is the second recipient, the bank takes the first cut through fees and increased interest
No, they are the first recipient. Why do you say they are the second? They get the money first, therefore they are the first recipient. The bank gets interest, but interest accrues after the loan has been made. Your claim makes no sense.
> The government gets to tap into the supply through perpetual deficit spending.
So once again, it appears that the borrowers are the first recipient!
Your last part shows you don't understand the economic laws of nominal pricing. There's no point me discussing this, as you could go and look up the theory yourself.
> why do they violently shut down competition?
They don't. Very few countries have laws restricting what currency you can use. Many people have created alternative currency systems. But very few people use them precisely because national currencies win in the market.
You're advocating a system which discourages saving. I'm pointing out a situation where lack of savings has a negative consequences for quality of life.
> Where is all the consumer inflation that they are allegedly creating?
The fundamental problem with inflationary policy is that it makes it so that dollars from the past purchase less food today than they would have previously, even though it is much easier to produce food today. You're calling it "consumer inflation" to avoid the glaring fact that every widget that has gotten easier to produce but yet remains the same price represents pure inflation. And as the rate of technological progress increases, this gap will grow ever larger.
> Yes they would, because we are entering a potential depression. Smoothing out means cutting when things are bad and increasing when things are good. You have to act at both ends to achieve stable prices.
But the fact they've hit zero shows that the average target has been chosen incorrectly over multiple cycles. Negative isn't just a curious property of a freely-tunable parameter - it's paying borrowers to take on debt with the hope that they'll spend it on something.. anything.. please?
Investors are understandably weary, and low rates can only mitigate this to an extent. Worthy investments would still be made with 1-2% rates, lower rates only perpetuate "no money down" and "users first profitability second" wishful thinking. The only thing that will fix general confidence is time.
> What evidence do you have that central banks have departed from their mandated inflation targeting regime?
I can't really claim that the central banks have deviated from their stated goal, when their stated goal is to devalue the currency as much as they can without pissing consumers off.
2002-2004. These were good times, yet the rate is solid at the lower end of the scale. A war should make creditors cautious, but rates were kept low to avoid any kind of economic slowdown that would make people realize an elective aggressive war has consequences.
The fact we're now talking about paying borrowers to take loans is precisely the consequence of failing to to keep the rates high enough.
> What do you mean when you say the economy is 'driven'?
Driven - Stimulated by an external source (rather than being left to steady-state)
> Sustainability is entirely orthogonal to monetary policy.
You haven't addressed my point. You can't claim it a virtue to lift masses out of poverty if they have the same proportion of wealth and the increased magnitude only comes from depleting natural resources as fast as possible. When the price of resource extraction goes up, the economy will slow back down, and they'll be left in deeper poverty.
> Why do you say they are the second?
The borrower pays the bank for the privilege of having access to the newly printed money. If the bank did not have first stab at the money, they wouldn't be able to attach their own conditions. Capiche?
> Your last part shows you don't understand the economic laws of nominal pricing
No, you're making an invalid assertion that the immediate consumer supply is fixed. By raising the prices of goods through monetary inflation, you short circuit the proper path which involves reduced demand for employment.
> Many people have created alternative currency systems
And they're allowed to exist as long as they stay local curiosities. When they grow and start attracting widespread attention, they are raided and neutered like Liberty Dollar and E-gold.
If economic actors anticipated future prices increases, they would be more inclined to buy in the present. Economic actors do make purchases despite anticipating price declines. One reason for that is time value, also known as future discounting. A computer available in the present is considered more valuable than a computer available in the future.
Inflation is not uniform. Low-income wages typically lag. (And, increasing the minimum wage leads to less employment by the marginal folks and just compresses wages at the bottom.)
Moreover, "lowest paid" isn't the only folks on the low-end of the system. Poor retired folks get slammed by inflation because the don't get any benefit from wage inflation.
For the last years it has been the other way around, especially in the US.
If you don't adress this you will only postpone the problem.
What would you do with the excess?
The problem is that directly inflating our way out has other ramifications.
One idea would be for the Federal Government is to directly subsidize risk in certain well-defined areas by paying some of the interest on certain loans through the Small Business Administration.