I have previously referenced my support for the idea, advocated by Keynes and Adam Smith, that low long term interest rates are a desirable stance for monetary policy. The claim about the effect of low rates is two fold:
(1) Low rates reduce the cost of investment and so encourage it.
(2) Low rates reduce the yields required to pay back debt incurred, and hence encourage more sustainable, less speculative investments. To phrase it conversely: high rates push people into speculation as they attempt to recoup the money they owe.
Commenter Roman P. is not convinced by this argument. I am willing to admit I have, thus far, provided insufficient evidence for this, mostly due to lack of data. However, I have assembled what data I can below, and believe it offers broad – though not definitive – support for this hypothesis.
A few caveats. First, let me establish clear criteria for what I consider to be ‘low rates.’ John Maynard Keynes wanted the long term interest rate to be as low as 2.5%; he even remarked that 3.5% would be too high for full employment...Unlearning Economics
Interest Rates: Too High, Not Too Low
A long term rate of below 3.5% implies an overnight rate close to zero. This in turn implies tightly controlling the inflation rate through fiscal policy rather than raising the interest rate, which involves using unemployment as a tool.
The idea (in the second paragraph of the article) that investment is “good”, ergo the more of it the better, is nonsense. A clean water supply and electricity are “good”. That doesn’t mean that increasing the consumption of water, electricity (or investment goods) any old how is desirable.
ReplyDeleteAs it explains in the introductory economics text books (and this is little more than common sense) there must be some OPTIMUM quantity of various goods and services to be produced/consumed if we are to maximise the benefit derived from those goods and services. And optimum production/consumption of each good is attained when the marginal benefit of each one equals marginal cost.
In the case of investment, the COST is the pain or disutility of the foregone consumption needed to fund investment, and the benefit is of course the cost saving that investments yield. Whether that optimum comes at a 2% or 4% or 6% interest rate is TOTALLY IMMATERIAL.
DOES ANYONE THINK THEY ARE GOING TO TRY TO RAISE RATES SOON ?
ReplyDeleteIN ADDITION TO TALK ABOUT BALANCING THE BUDGET, ALL THE DEFICIT PHOBIC TAX PAYER ON THE HOOK PURVEYORS ARE COMING ALONG MUCH FASTER THAN MMT.
MOSLER DOESN'T EVEN MAKE COMMENTS HERE ANYMORE.
"ARE COMING ALONG MUCH FASTER THAN MMT"
ReplyDeletewhat do you mean?
This comment has been removed by the author.
ReplyDelete"the COST is the pain or disutility of the foregone consumption needed to fund investment"
ReplyDeleteHow does "foregone consumption" fund investment?
"the benefit is of course the cost saving that investments yield"
That's only one possible benefit. It might not even be a net benefit if "cost saving" just means higher unemployment, lower wages, and all the benefits going to the top.
JKH has a new post up that's worth discussing:
ReplyDeletehttp://monetaryrealism.com/briefly-revisiting-s-i-s-i/
The only thing the captured PHD,s of the Fed are doing is increasing their position at the expense of us all, I refer you to Mishin.
ReplyDeleteYou can ponder all you like on what the Real interest rates are, you are wasting your time. The bank captured Fed board have completely destroyed any free market pricing models and now we are all communist party members of the ruling TBTF's. Only thing left to do now is to chip everybody.
Goog,
ReplyDelete"DOES ANYONE THINK THEY ARE GOING TO TRY TO RAISE RATES SOON ?"
imo NOT under Bernanke.... and if this "sequestration" goes thru, most think unemployment will go back over 8% even with the current BS participation rate ... Bernanke is looking for 6.5% UE or lower...
Those Fed minutes that came out depict a Fed that was "jumping the gun" on the 4th quarter results imo (ie the negative 4Q gdp).... premature celebration due to the decent 3rd quarter.... they are all now probably shitting their pants as we speak...
What are they going to do if UE shoots back over 8%? Propose confiscating all the $NFA so we here in the non-govt are left with no $NFA at all?
What a bunch of morons...
rsp,
"In the case of investment, the COST is the pain or disutility of the foregone consumption needed to fund investment, and the benefit is of course the cost saving that investments yield. Whether that optimum comes at a 2% or 4% or 6% interest rate is TOTALLY IMMATERIAL."
ReplyDeleteRalph - Not sure what you mean by TOTALLY IMMATERIAL? The whole issue of investment vs. consumption is really what politics is all about... no?
Regarding investment, Adam Smith and Karl Marx had something very important in common which is that human progress is predicated on the accumulation of Capital which is the essential element in liberating labor and bringing it to a higher level. The Soviets in the early post revolutionary period struggled with whether to invest in capital like electrification, plant, machinery and equipment or consumption.
By necessity this means that from one production cycle to another, the ratio of capital applied to labor must increase. This is the basis for increasing labor productivity and raising living standards for the broader population from one generation to another.
Politics is the practice of attempting to strike a balance between the development of the quality and power of Labor as reflected in living standards vs. the development of the means of production.
The Marxists would refer to this accumulation of capital as social surplus, whereas capitalists would think of it more in terms of profit and earnings but either way a growing ratio of capital relative to consumption as the economic pie grows larger results in rising absolute living standards. It means that there is progressively more and more investment available not merely to maintain existing plant, machinery, infrastructure and labor skills and corresponding wages but to upgrade it. Moreover, those upgrades to all these categories must expand exponentially to avoid economic stagnation and/or regression.
How does foregone consumption fund investment?
ReplyDeleteI'm skeptical of the idea that low rates promote more sustainable and less risky investment. Maybe more sustainable. But I would think that the lower the rate, the more likely people are to borrow to finance speculative investments. Didn't low mortgage financing rates help promote the speculative bubble in housing?
ReplyDeleteForegone consumption = saving.
ReplyDeleteA more interesting approach to the relationship that The Rombach Report notes is to realise that the trade-off between investment and consumption in the output-mix implies a dynamic trade-off in the benefits accruing to the host society in terms of that output-mix.
Higher investment today means higher output *in the future*, but it also means lower consumption *today*. Whereas lower investment today means higher consumption today and (counterfactually) lower consumption in the future. So what is the *optimal* level of saving?
In the present environment, I would think that what people mean by "encouraging investment" is encourage businesses to move invested funds out of low yield, low risk, highly liquid money-like assets into higher yield and higher risk business expansion projects. Surely with 7.9% unemployment in the US we need more such projects.
ReplyDeleteY asks how foregone consumption funds investment.
ReplyDeleteThe latter idea is an inescapable physical fact: it doesn’t even have anything much to do with economics.
Suppose we count investment as any asset lasting more than one year and assets lasting less than one year as consumption items. If Robinson Crusoe, or the US economy (to take a much bigger economy) want more assets lasting MORE THAN one year, people making up the economy will just have to consume fewer assets lasting LESS THAN a year.
That assumes “all else equal”, of course. I.e. it assumes a given number of hours worked. Plus it assumes no borrowing from abroad to fund investment.
The Rombach Report said...The Marxists would refer to this accumulation of capital as social surplus, whereas capitalists would think of it more in terms of profit and earnings
ReplyDeleteRight, the basic issue is distribution. Socialism and capitalism are different distribution systems. Capital investment is the driver and distribution is based on who controls the capital.
Under laissez faire, distribution is by market forces alone, irrespective of institutional arrangements that lead to inequality. It is also assumed that no one has a right to subsistence.
Under socialism, institutional arrangements are taken into account to eliminate the effects of power, privilege and economic rent. It is assumed that a subsistence wage is a human right and that any surplus above subsistence be distributed fairly, that is, irrespective of special interests, although not equally in an absolute numerical sense.
Which system would most people choose starting from a zero base (Rawlsian justice)?
Ralph,
ReplyDelete"That assumes..."
... full employment, full productive capacity, no population growth, a fixed supply of resources, no trade deficit...
So you need to make a lot of assumptions for your initial comment to make any sense.
Vimothy, you seem to be saying that if the US (private + public sectors) spends less and saves more, this will lead to higher investment in the present and higher consumption in the future.
ReplyDeleteHow does that work?
It works because output is an increasing function of capital. Therefore, at the margin, higher investment equates to higher output, and hence (for some values of saving), higher consumption in the future as well.
ReplyDelete(This dynamic is the subject of a very famous paper by the mathematician Frank Ramsey.)
ok, so US citizens and the govt spend less on consumption. This means lower sales of goods and services. And these lower sales encourage higher investment. How?
ReplyDeleteI don't think it actually *means* lower sales of goods and services, because GDP includes investment. It might *cause* lower sales of goods and services, among other things, and it might not.
ReplyDeleteI wasn't really thinking about business cycles or aggregate demand, though. I was thinking about the fact that, for any given level of GDP, a proportion is spent on consumption and a proportion on investment. There is a trade-off between the two in terms of economic growth. Is there then an optimal level of saving?
Point being, say that both Marxists and capitalists both want to make this "social surplus" (i.e. investment to income ratio) as large as possible, as the Rombach Report claims.
ReplyDeleteBut should society really want to do this? No, because if this ratio is as large as is possible, consumption is zero. In fact there is a dynamic trade-off between the two, and you probably need a way to think about that to make sense of the question of how large this social surplus should be.
the problem is I don't think you'll achieve higher investment by getting people (and govt) to save more and spend less. You need instead to simply increase investment, thereby creating higher savings as a result.
ReplyDeleteHey Tom from the wiki:
ReplyDelete"Rawls's intent, rather, was to demonstrate that the authentically valuable features of the common notions of freedom and equality could be integrated into a seamless unity which he called justice as fairness. By elucidating the proper perspective we should take when thinking about justice, Rawls hoped to demonstrate the apparent conflict between the two values to be illusory."
Looks like this Rawls saw the conflict as being between "freedom" and "equality" and the solution was "fairness"....
I thought it might be between "equality" and "fairness" themselves... I dont see "freedom" as fitting in at all...
rsp,
It works because output is an increasing function of capital. Therefore, at the margin, higher investment equates to higher output,
ReplyDeleteEven without innovation investment is required to maintain the existing state due to deterioration, which is captured nominally as depreciation. Investment has to equal depreciation just to say even.
Investment creates capital goods which are owned ultimately by household, so if all spending is on either capital goods or consumer goods, then funds spent on investment in capital goods rather than spent on consumption of consumer goods are a record of what household have saved, i..e., not consumed in the period. There is no causality running from saving to investment in this sense.
But what level of investment should you *want* to achieve? That is the question I am posing.
ReplyDeleteMatt see Rawl's Two Principles of Justice.
ReplyDeleteThe first is egalitarian liberty and the second is egalitarian distribution.
Getting the proper balance of investment and consumption right, called "balancing," is key. The US tends to over-consume and under-invest (domestically), while China tends to over-invest and under-consume. Both countries are said to need to "rebalance."
ReplyDeleteThis creates different challenges in the American and Chinese economies. As with the core and periphery in Europe. The USSR fell due to over-investment and under-consumption. It's the same problem that North Korea is having.
Getting the proper balance of investment and consumption right, called "balancing," is key.
ReplyDeleteRight.
And, in achieving this state, you probably need some way of thinking about what "balance" between investment and consumption actually entails.
You might even say you need a model of balance.
You might even say you need a model of balance.
ReplyDeleteYes, that is what economics is about, as you know. In a simple model with a closed economy and no government this is determined by interplay of marginal factors like cost of capital, return on capital, real wage, etc, in markets based on price discovery.
The problem is that such models are too simplistic to be representational of actual economic systems in play with each other in a competitive global dynamic where not only economics is a factor but also power, so that a significant factor is the militaries, for instance.
y said: "Vimothy, you seem to be saying that if the US (private + public sectors) spends less and saves more, this will lead to higher investment in the present and higher consumption in the future.
ReplyDeleteHow does that work?"
And....
vimothy said: "Point being, say that both Marxists and capitalists both want to make this "social surplus" (i.e. investment to income ratio) as large as possible, as the Rombach Report claims.
But should society really want to do this? No, because if this ratio is as large as is possible, consumption is zero. In fact there is a dynamic trade-off between the two, and you probably need a way to think about that to make sense of the question of how large this social surplus should be."
Picture a primitive subsistance farming society just barely scratching a living off the land. This is the very definition of a capital poor society where almost all their collective efforts are spent just to secure enough to consume. Compare that state of existence with a Star Trek like civilization which is obviously very capital intensive. In between these two extremes are stages of evolution in political economy that is defined by a growing ratio of Surplus divided by the sum of Constant Capital plus Variable Capital.
Surplus, net of overhead costs like education, legal, accounting, military, etc. as already discussed represents that wealth which is not otherwise consumed so that it can be reinvested in Constant Capital just to maintain existing plant, machinery and equipment at current levels, plus what paid out to Variable Capital which represents the aggregate wage bill for productive labor.
Call Surplus net of overhead costs S1, Constant Capital C and Variable Capital V, such that S1 / ( C+V ) must rise exponentially for there to be human progress and real increases in absolute living standards. In other words, the further away from the primitive state and the closer to a Star Trek like state of existence, the more "V" will shrink as a percentage of the global economy as a whole relative to S1 & C, while at the same time rising in absolute terms as evidenced by rising standards of living.
Watch out! We've got a Marxist over here (Rombarch Report).
ReplyDeleteThe problem is that such models are too simplistic to be representational of actual economic systems in play with each other
ReplyDeleteBut such models are not really designed to be representative of particular economies, any more than highly abstract post Keynesian models are designed to be representative of particular economies.
They're supposed instead to represent a particular *relationship*, in the same way that a simple Godley & Lavoie model might represent the relationship between government spending, the tax rate and output in general.
That's not to say that economics doesn't have more complicated models, or models designed to represent particular economies. But these are built to answer different questions to the one Ramsey asked.
BTW, Keynes described Ramsey's model as, "one of the most remarkable contributions to mathematical economics ever made, both in respect of the intrinsic importance and difficulty of its subject, the power and elegance of the technical methods employed, and the clear purity of illumination with which the writer's mind is felt by the reader to play about its subject."
Watch out! We've got a Marxist over here (Rombarch Report).
ReplyDeleteJK - In the checkered past of my youth I have to say guilty as charged, but you know how that old saying goes.... "Anyone who's not a communist when they're 18 years old has no heart, and anyone who still is a communist when they're 30 has no head." Unless you've read some of my posts here, I think you would have a hard time defining my outlook on political economy.
"Getting the proper balance of investment and consumption right, called "balancing," is key. The US tends to over-consume and under-invest (domestically), while China tends to over-invest and under-consume. Both countries are said to need to 'rebalance.'"
ReplyDeleteTom - I'm kind of surprised to read this comment by you, because I would have figured that you would think that there is a lack of aggregate demand in the US economy.
Rombach, I don't think the two are mutually exclusive.
ReplyDelete"Rombach, I don't think the two are mutually exclusive."
ReplyDeleteTom - Can you elaborate? I have often wondered whether US deficit spending stimulates as much or more economic activity in a country like China as it does here in the US. If the SS payroll tax cut or government spending boosts aggregate demand more than would otherwise be the case, consumers will use some of those extra dollars in their pockets to spend on products at WalMart or Home Depot, most of which is made in China these days.
Until countries like China decide that they want their populations to consume more and have higher standards of living, as opposed to being downtrodden proles, countries like the US are going to be doing a lot of the consumption on their behalf.
ReplyDeleteI see your point, and looks like consumption is on the rise in China, so we may see some changes in this area.
ReplyDeletevimothy I have said many times that I have no issue with economists building any model they please for whatever reason in economics. Where I have problems is when they transfer the conclusion of such models to policy formulation as though the model were representational, when it is clearly not.
ReplyDeleteFor example, economists excuse themselves for missing the crisis because the situation was beyond the parameters of the model. The obvious response is, now you tell us, after your at least implicitly led us to believe that you knew what the consequences of policy actions were. The queen had a right to be angry that her economists missed the crisis and they should have been embarrassed. Instead, they saw nothing wrong.
Tom - I'm kind of surprised to read this comment by you, because I would have figured that you would think that there is a lack of aggregate demand in the US economy.
ReplyDeleteEd, I'm stating the current thinking there, not my own, although I do think that rebalancing is called for in another way than is usually implied. I don't see trade imbalances as problems if handled properly, In fact, I see them as a good thing in a specific way.
I've said before that two things are necessary. First is for govts to use their policy space intelligently in order to run full employment with price stability, and secondly, there needs to be international coordination to get the emerging and developing countries up to speed without seriously undercutting the developed countries or creating a lot of negative externalities, especially unsustainable ones.
This is doable, especially if govts can control their nationalistic and military penchant. Basically, since the rise of the Prussian state, the goal of govt is to run strong industrial economies in order to generate economic power and military might rather than for social purposes. This is still the overarching dynamic.
Tom - Can you elaborate? I have often wondered whether US deficit spending stimulates as much or more economic activity in a country like China as it does here in the US. If the SS payroll tax cut or government spending boosts aggregate demand more than would otherwise be the case, consumers will use some of those extra dollars in their pockets to spend on products at WalMart or Home Depot, most of which is made in China these days.
ReplyDeleteI look at "the economy" as the global economy (closed). The US and China are like California and maybe North Carolina, while the US and some African country are like California and Alabama. Slowly but surely, the standard of living is equalizing throughout the US because of the open flow. Same things needs to happen worldwide instead of countries taking advantage of each other and especially competing militarily.
Until countries like China decide that they want their populations to consume more and have higher standards of living, as opposed to being downtrodden proles, countries like the US are going to be doing a lot of the consumption on their behalf.
ReplyDeleteI don't think this is a matter of deciding. It's very tricky transitioning from one type of society to another, basically peasant agricultural-analog to worker-industrial-digital. China is handling it pretty well considering the awesomeness of the project. Russia actually did a pretty good job of it, too, in spite of all the maligning.
All the US had to do was eradicate the indigenous population.
Rombach Report,
ReplyDeleteI noticed you using Marxian terminology. That's all. Just poking fun!
I have no idea your views on political economy.
"China is handling it pretty well"
ReplyDeleteNo, they're obviously exploiting their own population for "geo-political" aims.
Perhaps they are shit-scared of the US and the rest of the world, I don't know.
y, every country builds its economy based chiefly on investment for one big reason, and that is as a foundation for a powerful military to both for defense and to project power on the world stage. Large countries like China even more so. China and Russia did quite well at this, and now both challenge the US militarily. Neither can overcome the US alone, but together present a formidable challenge.
ReplyDeleteJapan and Germany also become great industrial powers after WWII, and now Germany is poised to emerge as the leader of a new European empire capable of challenging Russia, China, or the US but not a combination of two of them.
Presently, the US allied with a Europe organized under Germany and Japan can overcome any challenge, including a Chinese-Russian axis.
Everything has to be viewed in terms of the the next round in the Great Game, especially since that is where the energy resources are.
Tom - That's a pretty interesting take on the geo-political balance of power. Now, throw into the mix a precipitating event, like for example Israel and/or the US attacking Iran to take out its nuclear facilities. I could see Pakistan aligning with Iran backed by Russia and China, which would probably cause India to align with US, Euro-zone (under German stewardship) and Japan. This would also probably destabilize the Korean peninsula and God knows what could happen there. My guess is that any moves by the Obama administration to become more involved in the Syrian civil war would be a precursor to action against Iran.
ReplyDeleteRight, Ed, this is chess game, and the one thing certain about it is that Western powers are very leery of getting involved in land war in Asia, including Central Asia, due to the history, and as it turns out that where a lot of the energy resources of the planet are located. Alexander was the only Western general able to manage it successfully.
ReplyDeleteIt's like once you've got enough money, buying stuff maybe gets boring? So POWER is the money of the most wealthy. And what's the fun in having power without wielding it?
ReplyDeleteFrom my meager perspective: let's just create abundant renewable energy at home and let others fight over the black gold.
Update....
ReplyDeleteU.S. Offers Training and Other Aid to Syrian Rebels
http://www.nytimes.com/2013/02/28/world/middleeast/us-expands-aid-to-syrian-rebels.html?pagewanted=all&_r=0