Monday, 16 December 2013

Weird is Normal

My latest post at Pieria:

"Three years ago, Nick Rowe produced this post describing a “weird world” – a world in which the equilibrium interest rate is at or below the long-term growth rate of the economy, rather than above it as we are used to. In such a world, bubbles are inevitably created as investors search for positive yield. This is also the world recently described by Larry Summers.
"But I don’t think this world is weird. I think it is actually normal, and we have been living in a weird world of unstable Ponzi schemes that eventually crash and reset." 

Read on here.

23 comments:

  1. The thesis is based on negative real interest rates. This is proposed to promote enterprise - but enterprise is something that creates value , it is not enterprise if it appears to turn a profit because the unit of account is diminishing in value.



    You haven't made a case for the buying power of savings actually diminishing. If returns to safe assets are related to the growth of the economy then there is no reason for the buying power of savings to fall when the economy is static. There is no cost and price in "remembering" what savers have produced for the community without consuming. Post office National savings are less than the general rise in prices are they not.


    ReplyDelete
    Replies
    1. Dinero, I am not talking about purchasing power. Andy Harless did, but I have for the purposes of this post ignored inflation. All my remarks are about real growth and real interest rates.

      However, since you want to introduce purchasing power: if growth is flat and there is inflation (i.e. stagflation), then the purchasing power of non-indexed bonds would fall. This is as it should be. It's not reasonable to expect future generations to provide free guarantees that the unconsumed production of the current generation will always retain its value.

      Delete
    2. This comment has been removed by the author.

      Delete
    3. I agree it is logically consistent if you put it simply that in the situation that if the economy is making less stuff per person then what can be consumed is less, by savers and earners alike.

      Delete
  2. You say in post dated 14-Dec that if Germany could raise domestic interest rates this would attract more productive investment at home (and therefore potentially help reduce current account surplus). However, this more recent post suggests that higher risk free rates would discourage productive investment in favour of safe assets. Agree with the latter argument, but not sure how this squares with the former?

    ReplyDelete
    Replies
    1. Ah. I think you've misconstrued my German post. I suggested that the German government should borrow more in order to invest. This would have the effect of raising real interest rates on both risk-free and risk-bearing assets, since risk-bearing assets trade at a premium to risk-free. The higher returns would be likely to attract private sector investment. You might call it government "priming the pump".

      Delete
    2. That helps, thanks

      Delete
    3. A high rate can’t be something that attracts investment on its own as it is the result of the investment being unattractive due to a lower risk loan having a high rate.

      Delete
    4. It's not attractive "on its own", it's attractive relative to the lower rate on a lower risk loan. If there are high rates on lower risk loans, therefore, rates on higher risk ones must be even higher. The overall effect is that everyone is paying too much for credit, but at the margin high rates may mean investment in risk-free assets rises relative to risky. That's why central bank strategies for monetary stimulus have aimed to depress risk-free rates - it's investment in risky assets that drives productive enterprise.

      Delete
    5. This comment has been removed by the author.

      Delete
    6. if there are high rates on lower risk loans, therefore, rates on higher risk ones must be even higher. that is true
      and central banks raise interest rates by raising them on Gilts and thus the rates on risky lending go up because the return on the safest asset sets the base line . that is also true
      Therefore raising interest rates does not encourage Risky lending.

      The high rates are an the effect of lending behaviour so they can't be a cause of lending behavior.

      Delete
    7. I didn't say raising interest rates encourages risky lending. I said the opposite.

      Depressing interest rates does, at the margin, encourage risky lending.

      Delete
    8. You sere saying in the context of Germany Investment Problem post of 14 Dec , raising interest rates to encourage domestic investment and also the higher returns would be likely to attract private sector investment in this comment thread above.

      Delete
    9. See my reply to Anonymous above. I suggested that the German government should borrow to invest, which would have the effect of raising interest rates. The combination of more public sector investment with higher returns might attract private sector investors, since investors hunt in packs. I did NOT suggest raising interest rates in order to attract private sector investment without public sector involvement.

      Delete
  3. Interest payments are just transfer payments, so their impact on stability has to be seen in the context of other transfer payments (principally taxes and benefits). Depending on the structure of these other transfers, there is no reason per se why the interest rate on safe assets has to be below the growth rate. (See for example http://www.levyinstitute.org/pubs/wp_494.pdf ). There is no public sector in Samuelson, so you don't get these transfer flows, but by the same token his assets aren't actually claims on anybody, so they can't really be thought of as safe assets.

    Of course, it may be that excessive interest rates entails tax and transfer rates that are unpalatable, but that's a different issue.

    ReplyDelete
    Replies
    1. They don't necessarily have to be below the growth rate, but they certainly shouldn't be above it. If real returns on safe assets are persistently higher than the long-run growth rate they are an unstable Ponzi scheme and will inevitably cause a crash at some point.

      Delete
    2. But is that just your intuition? You admit you haven't done the maths. There is maths in the paper I referenced and it shows the opposite (see page 12). If you are basing this on any other work, I'd be interested in the reference. Different results can obviously arise from different assumptions.

      Delete
    3. Er no, Nick, it doesn't actually talk about the economic effects of returns persistently above the growth rate. It talks about the stability of government debt dynamics when there are interest rate shocks. Godley's baseline model actually has a real interest rate below the growth rate of the economy (inflation 2%, nominal interest rate 3%, growth 2.5%). See pages 9-10.

      What Godley is saying is that in conditions of full employment, for the government deficit to stabilise after an interest rate shock, government spending adjusted for the new interest rate must grow at the same rate as the economy. That is eminently sensible. But it is not the situation we have. We don't have full employment, for one thing.

      However, from the table on page 10 and Godley's subsequent mathematical analysis it is clear that maintaining an interest rate persistently higher than the growth rate requires a primary surplus. National income accounting requires that (assuming external trade is balanced) a persistent primary surplus reduces the savings of the private sector. In other words, in order to maintain above-growth returns to holders of safe assets, income earners must be taxed more highly than required to meet government spending commitments. Over time, this will impoverish income earners: if they respond to it by increasing indebtedness, there will eventually be instability followed by a crash.

      Godley demonstrates that the primary surplus becomes stable if interest-adjusted government spending is allowed to grow at the same rate as the economy: but it is still extracting more money from the private sector than it returns as government spending. Admittedly, the difference goes to the holders of government debt, some of whom will spend that money into the economy. If all of them did, it would be a wash. But not all of them will. Many (probably most, actually) will save (capitalise) that interest rather than spending it. It is therefore a wealth transfer from income earners (who are taxed on their labour) to asset holders (who are given a tax credit), most of which does not recycle back to the benefit of income earners but goes to increase the wealth of asset holders. Over time, this is unsustainable.

      Delete
    4. Oh, and I didn't cover this in the post, but maintaining real interest rates persistently below the growth rate requires a primary deficit - as indeed Godley's analysis shows. Nick Rowe pointed this out in the comments on Andy Harless's post.

      Delete
    5. I think Frances is right.

      For a constant debt/GDP ratio, you need:

      Primary surplus/GDP = (r-g)(Debt/GDP) where r is interest rate and g is growth rate, (either both nominal or both real)

      Run a surplus bigger than that and Debt/GDP falls over time.

      If (r-g) is negative, the primary surplus needs to be negative too.

      Delete
    6. I'd agree with that, Nick, but that was sort of my point, i.e. that you can't determine the consequence of r - g without knowing about tax and spend.

      Delete
  4. Hi Frances,

    You have mentioned before how property in the UK has become a 'water hole' for the wealthy. Don't low interest rates encourage water holes like this? How can we keep interest rates low and solve the water hole problem? Government doesn't seem to be doing very much to tackle the supply side. What would you do?

    Thanks,

    Matt.

    ReplyDelete
    Replies
    1. Government should be providing more safe assets. In this post I talked about government debt, but if property is being used as a safe asset, we need more of that too. They could use some of the proceeds from additional debt issuance to do a limited debt jubilee to relieve the pressure on overborrowed households and reduce the risk of bankrupting the banks as housing supply increases. And they could use some more of the proceeds to, er, build houses - if the intention is to relieve safe asset pressure, then these should be built for sale not social rent.

      I'm sure people will think up lots of reasons why this is a bad idea, but to me, if safe assets should be produced to meet demand, we need more houses and I don't care whether they are built by the private sector or the public sector.

      Delete