An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
I agree with Warren and for a whole string of reasons which would take too long to list here. But here's just a couple.
1. There is little relationship between interest rates and investment spending. See this Fed study: http://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf
2. There is no relationship between base rates and credit card rates. See
3. The government / central bank machine should issue whatever amount of base money is needed to keep the economy at full employment. That's it. As for issuing so much that government then has to borrow some of it back and pay interest on it, that's just lunatic.
Ralph, it's well-known that business investment is inelastic to interest rate. However, private investment (housing) and consumer spending responds to interest rate changes . In other words, it's appropriate to say that the IS curve slopes downward and that monetary policy has an effect on the real economy.
"However, private investment (housing) and consumer spending responds to interest rate changes "
And the saver response offsets that - they stop spending because they don't have an income and loans get pared down much more quickly, plus more saving is required because of a lack of compounding
So it's not appropriate at all. Consumers come in two flavours. What interest rate does is try and exploit the time differential between the two sets of people. And the lower interest rates go, the less effect that has.
Interest rates have uncertain effects that do not fit with what people think should happen. It's like throwing your weight around in a car to try and get the car to steer.
Why do that when there is a much simpler alternative - grab the steering wheel and turn it.
Neil, I have no problem with the second part of your comment about grabbing the steering wheel...But in regard to your first point, what do you mean 'the saver response offsets that'? Are you saying saving is elastic to changes in interest rates? Empirically, there's isn't much evidence of that.
circuit I dont think we've had any opportunities (other than at present 0%) to do much empirical analysis....
iow for most of history under the FFNC era since early 70's we've had substantially positive rates...
I dont think there is a substantive difference between 6% or 9% to savers trying to gain some income from savings....
But there is a substantive difference right now at approx 0%....
Look at some ERISA saver here in the US who may have been fortunate enough to squirrel away $250k: at 6% that is $15k annual over $1k/mo.
Now here at 0.5% that is $1,250 annual or about $100/mo. so that is quite a difference in household income terms...
Just speaking for myself I dont support Warren on this as people have been trained to expect perhaps 5% to 6% risk free rates.... so if we just stay here at 0% these people are screwed... and they are NOT the "1%" or whatever... they are middle class savers who are getting screwed royally...
It's not the rate, it's the risk. Why should government support safe saving at a high rate of interest? What's the public purpose in that.
If people want a high rate of interest under capitalism then they should save in financial instruments that either pay interest or dividends, or carry a reasonable expectation of capital gains. Or they can invest in production like capitalists are supposed to do.
I can agree that there is public purpose in supporting "safe" saving for very small savers. We already have CD's for that, and EE/E bonds exist for that purpose, too.
3 mo, tsys is enough for other purposes.
Why should government support other "safe" saving in a capitalistic system?
If a majority of people don't want capitalism, they should say so and cut to the chase. But to have ersatz capitalism that is really socialism for the well-off is just BS. The well-off want to have their cake and eat it, too, while those at lower end of the middle and the bottom scrounge.
Tom, everything you say is quite sensible but I think there's probably room in a capitalist system for the govt to assist workers to save for retirement. Nersysian and Wray put forward a good idea here: http://www.levyinstitute.org/pubs/hili_109a.pdf
Page 3: "Workers would be far better off if their employers were obligated to fully fund pensions with investments restricted to Treasury debt. At most, each pension plan would require a very small management staff that could simply log on to www.treasurydirect.gov to transfer funds out of the employing firm’s bank deposit and into Treasuries."
On a different issue, is Warren here claiming that borrowers don't have a higher propensity to consume than savers? If so, this sounds very odd to me. Don't know what you think...
"For every dollar borrowed there is a dollar saved, so any reduction in interest costs for borrowers corresponds to an identical reduction for savers. The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers."
I go with Warren's proposal for unlimited liquidity at zero for all solvent members of the payments system, and an unlimited guarantee of bank savings. There is not operational reason for continuing government debt issuance other than 3 mo tsys for larger savers and EE/E bonds for smaller savers.
We don't need no stinkin' bond market in tsys. It serves no public purpose that can't be dealt with more efficiently and effectively under capitalist principles of risk/reward.
Interest on government bonds is essentially economic rent where bond holders get paid out of the public trough for using a default-free parking place. What's capitalistic about that?
There are several things in play here. First, the problems of the capitalism arise mostly from the capital vs labor share owing to the power relationships. This is justified on the need to accumulate capital. Economic rent has nothing to do with capital accumulation, and most gains in contemporary capitalism are from economic rent. The priority is eliminating the preponderance of economic rent and that can only happen by labeling it.
If one goes to a psychologist or psychotherapist with an issue, the practitioner will begin to label one's foibles so that one can recognize them when they arise. Merely labeling is often sufficient to resolve the issue. Same with some types of meditation in which the meditator is instructed to label thoughts and feelings, which serves to attenuate them.
The second reason is that most people don't understand enough of monetary economics to know the purpose of public debt. They are under the illusion that a currency sovereign needs to tax or borrow to get funding. This also brings in the loan funds doctrine, crowding out, and a host of other illusions that would disappear with elimination of Treasury debt issuance instead of currency issuance.
Thirdly, many people think that ZIRP means zero interest rates when, of course, it does not. Private lenders expend credit based on risk and require appropriate discounts in terms of down payment and collateral and set interest rates in terms of risk premia. A ZIRP would just eliminate the spread that the cb controls through the policy rate, making interest rates generally lower and favoring investment, especially housing.
Fouthly,there are a lot of things wrong with using monetary policy, not the least of which is that it puts a board of unelected and unaccountable technocrats, at the helm of a command system. At least some of those people have conflicts of interest, too. The other reason to eschew monetary policy is that it is inefficient and ineffective at achieving its mandate. Finally, it gets the fiscal authority off the hook in making key decisions about economic policy.
It seems to me that Warren has thought this out carefully, and it's a good plan as far as I can see.
"On a different issue, is Warren here claiming that borrowers don't have a higher propensity to consume than savers? If so, this sounds very odd to me. Don't know what you think..."
I am not sure what Warren means there, but most borrowing is for spending. Much if not most borrowing is either for real investment or financing acquisition of saving instruments including existing housing being sold by the owner (financial "investment" is saving). Borrowing chiefly for consumption is usually indicative of economic dysfunction, e.g, based on unequal income distribution and high saving rate at the top tier that is not offset by government.
Once borrowing creates credit money, someone saves that money in every transaction until the next transaction, which may be for further real investment, saving in another financial instrument or consumption. It looks to me like lower rates would chiefly increase velocity and be stimulative in that way rather than providing interest for consumption. Functional finance could address the changing effect of that.
John Cochrane made an interesting point in his paper above interest on reserves: fiscal policy usually changes in response to monetary policy changes. When the central bank puts interest rates up, fiscal policy becomes contractionary, as policy makers become worried about the effect of higher interest rates on the budget. Cochrane suggests it is actually this fiscal response which is to blame for much of the effects of higher rates. Long term, if the central bank set rates high and the fiscal authority kept running large deficits, the effect would be *inflationary*. Godley and Lavoie reach similar conclusions in Monetary Economics. Then there is the interesting case of the 'Fisher Effect', which posits that higher interest rates are inflationary in the longer term. This is because the economy is only capable of producing a certain real return over time, so if interest rates are set above that over a long time, prices will simply rise to make up the difference between the nominal rate and the real rate (so you'll get inflation).
"The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers."
This seems wrong.
More borrowing creates more saving. I borrow from a bank, pay the money to you, you now have more savings than before.
Theoretically the process starts with a bank loan or with government spending, not with a saver walking into a bank to deposit money (the money has to come from somewhere first).
The point about EE/E bonds is that they are not traded hence have no liquidity unless redeemed. They really act as the "savings bonds" they were created as during wartime to reduce spending power. They would have no purpose in the system in financing government as tsys are now believed to do.
They would not be funded by deficits so they would compete with other financial instruments. Therefore, the yield would have to be low or else eligibility limited. I would encourage a higher rate with limited eligibility aimed at a particular type of potential saver.
What I mean is that the government can design actual savings bonds provided on demand for small savers, such as a permanent 3% 10 year, or even a TIPS. The point is that this bond issuance would be completely separate from fiscal policy, offered as a public service, unlike now.
With the highly liquid tsy mkt, tsys don't function to increase saving in the sense of "neutralizing money," as it often presumed. Thus it is thought that if the government issued currency directly without a debt offset it would be highly inflationary. False logic. Parking funds in tsys doesn't necessarily affect the ability to spend since bonds can be liquified instantly or used as collateral. Tsys are a primary source of collateral for repo for example. (Issuance of 3 mo tsys would suffice for repo collateral.)
Warren is right: learn to "capitalism" or drop the bullshit already. Risk/reward and all that, if you want a survival subsidy, ask for a BIG or a JG. Is lame, the next thing is to ask the FED to buy the stock market so prices can never fall. What's the point of having 'markets' then? Capital markets are just the same, don't expect risk free guaranteed returns in a capitalistic economy.
Currency is meant to circulate and be invested with risk, not to be hoarded eternally as a vehicle to generate an income stream risk free. We can have social policies to avoid starvation because lack of income, but giving subsidies regardless of your previous financial capital is dumb bad incentives (after all, this increases savings desires and frictions). Bigger safety nets for the non-wealthy elder + less subsidies in the form os risk free guaranteed returns = win situation for everyone (except for the cronies).
philippe100: "More borrowing creates more saving. I borrow from a bank, pay the money to you, you now have more savings than before."
Actually, several things happen. First, borrowing for investment in an endogenous money system creates income from investment spending so that investment results in saving rather than the other way around. "Investment creates its own saving."
Secondly, some borrowing liquifies prior real saving, e.g., in housing as the seller gets paid in the money borrowed, after paying the remaining mortgage loan to the bank, of course. Often the seller turns around and buys another house, and so on.…
Thirdly, some borrowing is for consumption which becomes others' income that is distributed across consumption, saving and investment. Credit cards have greatly increased both spendable funds and velocity, for example, as long as income supports drawing on the future.
Using monetary policy to increase interest rates is supposed to decrease investment and increase saving by increasing liquidity preference. What actually happens is that by raising the cost of borrowing, endogenous money creation contracts as fewer loans result in less deposits. Monetary policy operates chiefly through the housing channel with changes in mortgage rates relative to the monthly nut. Higher mortgage rates make housing more costly to carry.
When housing slows so does housing related consumption, which is a huge factor in the economy. This is a big reason for the slow recovery, even with historically low rates. Incomes aren't there to support borrowing on tighter credit standards post-crisis.
18 comments:
I agree with Warren and for a whole string of reasons which would take too long to list here. But here's just a couple.
1. There is little relationship between interest rates and investment spending. See this Fed study:
http://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf
2. There is no relationship between base rates and credit card rates. See
http://uk.creditcards.com/credit-card-news/credit-card-interest-rates-bank-rates-1360.php
3. The government / central bank machine should issue whatever amount of base money is needed to keep the economy at full employment. That's it. As for issuing so much that government then has to borrow some of it back and pay interest on it, that's just lunatic.
Ralph, it's well-known that business investment is inelastic to interest rate. However, private investment (housing) and consumer spending responds to interest rate changes . In other words, it's appropriate to say that the IS curve slopes downward and that monetary policy has an effect on the real economy.
"However, private investment (housing) and consumer spending responds to interest rate changes "
And the saver response offsets that - they stop spending because they don't have an income and loans get pared down much more quickly, plus more saving is required because of a lack of compounding
So it's not appropriate at all. Consumers come in two flavours. What interest rate does is try and exploit the time differential between the two sets of people. And the lower interest rates go, the less effect that has.
Interest rates have uncertain effects that do not fit with what people think should happen. It's like throwing your weight around in a car to try and get the car to steer.
Why do that when there is a much simpler alternative - grab the steering wheel and turn it.
Neil, I have no problem with the second part of your comment about grabbing the steering wheel...But in regard to your first point, what do you mean 'the saver response offsets that'? Are you saying saving is elastic to changes in interest rates? Empirically, there's isn't much evidence of that.
circuit I dont think we've had any opportunities (other than at present 0%) to do much empirical analysis....
iow for most of history under the FFNC era since early 70's we've had substantially positive rates...
I dont think there is a substantive difference between 6% or 9% to savers trying to gain some income from savings....
But there is a substantive difference right now at approx 0%....
Look at some ERISA saver here in the US who may have been fortunate enough to squirrel away $250k: at 6% that is $15k annual over $1k/mo.
Now here at 0.5% that is $1,250 annual or about $100/mo. so that is quite a difference in household income terms...
Just speaking for myself I dont support Warren on this as people have been trained to expect perhaps 5% to 6% risk free rates.... so if we just stay here at 0% these people are screwed... and they are NOT the "1%" or whatever... they are middle class savers who are getting screwed royally...
It's not the rate, it's the risk. Why should government support safe saving at a high rate of interest? What's the public purpose in that.
If people want a high rate of interest under capitalism then they should save in financial instruments that either pay interest or dividends, or carry a reasonable expectation of capital gains. Or they can invest in production like capitalists are supposed to do.
I can agree that there is public purpose in supporting "safe" saving for very small savers. We already have CD's for that, and EE/E bonds exist for that purpose, too.
3 mo, tsys is enough for other purposes.
Why should government support other "safe" saving in a capitalistic system?
If a majority of people don't want capitalism, they should say so and cut to the chase. But to have ersatz capitalism that is really socialism for the well-off is just BS. The well-off want to have their cake and eat it, too, while those at lower end of the middle and the bottom scrounge.
Tom, everything you say is quite sensible but I think there's probably room in a capitalist system for the govt to assist workers to save for retirement. Nersysian and Wray put forward a good idea here:
http://www.levyinstitute.org/pubs/hili_109a.pdf
Page 3: "Workers would be far better off if their employers were obligated to fully fund pensions with investments restricted to Treasury debt. At most, each pension plan would require a very small management staff that could simply log on to www.treasurydirect.gov to transfer funds out of the employing firm’s bank deposit and into Treasuries."
On a different issue, is Warren here claiming that borrowers don't have a higher propensity to consume than savers? If so, this sounds very odd to me. Don't know what you think...
"For every dollar borrowed there is a dollar saved, so any reduction in interest costs for borrowers corresponds to an identical reduction for savers. The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers."
I go with Warren's proposal for unlimited liquidity at zero for all solvent members of the payments system, and an unlimited guarantee of bank savings. There is not operational reason for continuing government debt issuance other than 3 mo tsys for larger savers and EE/E bonds for smaller savers.
We don't need no stinkin' bond market in tsys. It serves no public purpose that can't be dealt with more efficiently and effectively under capitalist principles of risk/reward.
Interest on government bonds is essentially economic rent where bond holders get paid out of the public trough for using a default-free parking place. What's capitalistic about that?
There are several things in play here. First, the problems of the capitalism arise mostly from the capital vs labor share owing to the power relationships. This is justified on the need to accumulate capital. Economic rent has nothing to do with capital accumulation, and most gains in contemporary capitalism are from economic rent. The priority is eliminating the preponderance of economic rent and that can only happen by labeling it.
If one goes to a psychologist or psychotherapist with an issue, the practitioner will begin to label one's foibles so that one can recognize them when they arise. Merely labeling is often sufficient to resolve the issue. Same with some types of meditation in which the meditator is instructed to label thoughts and feelings, which serves to attenuate them.
The second reason is that most people don't understand enough of monetary economics to know the purpose of public debt. They are under the illusion that a currency sovereign needs to tax or borrow to get funding. This also brings in the loan funds doctrine, crowding out, and a host of other illusions that would disappear with elimination of Treasury debt issuance instead of currency issuance.
Thirdly, many people think that ZIRP means zero interest rates when, of course, it does not. Private lenders expend credit based on risk and require appropriate discounts in terms of down payment and collateral and set interest rates in terms of risk premia. A ZIRP would just eliminate the spread that the cb controls through the policy rate, making interest rates generally lower and favoring investment, especially housing.
Fouthly,there are a lot of things wrong with using monetary policy, not the least of which is that it puts a board of unelected and unaccountable technocrats, at the helm of a command system. At least some of those people have conflicts of interest, too. The other reason to eschew monetary policy is that it is inefficient and ineffective at achieving its mandate. Finally, it gets the fiscal authority off the hook in making key decisions about economic policy.
It seems to me that Warren has thought this out carefully, and it's a good plan as far as I can see.
"On a different issue, is Warren here claiming that borrowers don't have a higher propensity to consume than savers? If so, this sounds very odd to me. Don't know what you think..."
I am not sure what Warren means there, but most borrowing is for spending. Much if not most borrowing is either for real investment or financing acquisition of saving instruments including existing housing being sold by the owner (financial "investment" is saving). Borrowing chiefly for consumption is usually indicative of economic dysfunction, e.g, based on unequal income distribution and high saving rate at the top tier that is not offset by government.
Once borrowing creates credit money, someone saves that money in every transaction until the next transaction, which may be for further real investment, saving in another financial instrument or consumption. It looks to me like lower rates would chiefly increase velocity and be stimulative in that way rather than providing interest for consumption. Functional finance could address the changing effect of that.
John Cochrane made an interesting point in his paper above interest on reserves: fiscal policy usually changes in response to monetary policy changes. When the central bank puts interest rates up, fiscal policy becomes contractionary, as policy makers become worried about the effect of higher interest rates on the budget. Cochrane suggests it is actually this fiscal response which is to blame for much of the effects of higher rates. Long term, if the central bank set rates high and the fiscal authority kept running large deficits, the effect would be *inflationary*. Godley and Lavoie reach similar conclusions in Monetary Economics. Then there is the interesting case of the 'Fisher Effect', which posits that higher interest rates are inflationary in the longer term. This is because the economy is only capable of producing a certain real return over time, so if interest rates are set above that over a long time, prices will simply rise to make up the difference between the nominal rate and the real rate (so you'll get inflation).
**about interest on reserves.
Tom I think the EE rate is a derivative of the UST rates.... so 0 USTs then zero EEs...
A household that has 250k @ 6% in ERISA to supplement SS is not wealthy...
Rsp
Warren Mosler:
"The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers."
This seems wrong.
More borrowing creates more saving. I borrow from a bank, pay the money to you, you now have more savings than before.
Theoretically the process starts with a bank loan or with government spending, not with a saver walking into a bank to deposit money (the money has to come from somewhere first).
The point about EE/E bonds is that they are not traded hence have no liquidity unless redeemed. They really act as the "savings bonds" they were created as during wartime to reduce spending power. They would have no purpose in the system in financing government as tsys are now believed to do.
They would not be funded by deficits so they would compete with other financial instruments. Therefore, the yield would have to be low or else eligibility limited. I would encourage a higher rate with limited eligibility aimed at a particular type of potential saver.
What I mean is that the government can design actual savings bonds provided on demand for small savers, such as a permanent 3% 10 year, or even a TIPS. The point is that this bond issuance would be completely separate from fiscal policy, offered as a public service, unlike now.
With the highly liquid tsy mkt, tsys don't function to increase saving in the sense of "neutralizing money," as it often presumed. Thus it is thought that if the government issued currency directly without a debt offset it would be highly inflationary. False logic. Parking funds in tsys doesn't necessarily affect the ability to spend since bonds can be liquified instantly or used as collateral. Tsys are a primary source of collateral for repo for example. (Issuance of 3 mo tsys would suffice for repo collateral.)
Warren is right: learn to "capitalism" or drop the bullshit already. Risk/reward and all that, if you want a survival subsidy, ask for a BIG or a JG. Is lame, the next thing is to ask the FED to buy the stock market so prices can never fall. What's the point of having 'markets' then? Capital markets are just the same, don't expect risk free guaranteed returns in a capitalistic economy.
Currency is meant to circulate and be invested with risk, not to be hoarded eternally as a vehicle to generate an income stream risk free. We can have social policies to avoid starvation because lack of income, but giving subsidies regardless of your previous financial capital is dumb bad incentives (after all, this increases savings desires and frictions). Bigger safety nets for the non-wealthy elder + less subsidies in the form os risk free guaranteed returns = win situation for everyone (except for the cronies).
Wish he still allowed commenting on his blog so we could ask questions. There are two statements I wish he would elaborate further on:
1.The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers.
2.In fact, theory and evidence points to the reverse- higher rates tend to weaken a currency and support higher levels of inflation.
philippe100: "More borrowing creates more saving. I borrow from a bank, pay the money to you, you now have more savings than before."
Actually, several things happen. First, borrowing for investment in an endogenous money system creates income from investment spending so that investment results in saving rather than the other way around. "Investment creates its own saving."
Secondly, some borrowing liquifies prior real saving, e.g., in housing as the seller gets paid in the money borrowed, after paying the remaining mortgage loan to the bank, of course. Often the seller turns around and buys another house, and so on.…
Thirdly, some borrowing is for consumption which becomes others' income that is distributed across consumption, saving and investment. Credit cards have greatly increased both spendable funds and velocity, for example, as long as income supports drawing on the future.
Using monetary policy to increase interest rates is supposed to decrease investment and increase saving by increasing liquidity preference. What actually happens is that by raising the cost of borrowing, endogenous money creation contracts as fewer loans result in less deposits. Monetary policy operates chiefly through the housing channel with changes in mortgage rates relative to the monthly nut. Higher mortgage rates make housing more costly to carry.
When housing slows so does housing related consumption, which is a huge factor in the economy. This is a big reason for the slow recovery, even with historically low rates. Incomes aren't there to support borrowing on tighter credit standards post-crisis.
Thanks Tom for the detailed response.
I also think this is a huge problem with the focus on monetary policy:
"Finally, it gets the fiscal authority off the hook in making key decisions about economic policy."
Totally agree.
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