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The case for negative interest rates

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2/6/2016 11:32:22 AM
Posted: 10 months ago
Silvio Gesell proposed a tax on money in his work the Natural Economic Order. His ideas get some attention in recent years because central banks start to venture into negative interest rates. I think there is reason to believe that a tax on currency (central bank money and cash) of 0.5% to 1% per month combined with a maximum interest rate of zero on loans could improve the economy and reduce the number and intensity of financial crises in the future. As a consequence the economy could do better.

A holding tax on currency and a maximum interest rate of zero on loans can have the following consequences:
* the holding tax does not apply on bank deposits and loans so that it can be attractive to lend out money at zero or even negative interest rates;
* the holding tax can help to balance the markets for money and capital at a negative interest rate so that there is no need for stimulus;
* lower interest rates can make more investments profitable and this can help to improve the economy;
* the maximum interest rate of zero can prevent the economy from overheating as there will be less credit when other investments are more attractive;
* the maximum interest rate of zero can reduce reckless lending because there is no reward for taking excessive risk.

Banks can lend out money at a maximum rate of zero so deposit accounts can have negative yields that might amount to -2% to -3% annually. There could be a fixed amount of currency units and there would be a reserve requirement so that there probably is no price inflation. If there is economic growth then the value of the currency can rise because economic growth means that more products and services become available while the amount of money remains the same. So, zero interest rates could actually be a positive real return.

Interest free money didn't work in the past. So why do I think that it might work now? There are a few reasons why I think that might be the case.

The growth of capital helped to bring down interest rates in the following way:
* Throughout history returns on investments have mostly been higher than economic growth. This is unsustainable when most capital income is reinvested because this means that at some point capital income will grow at the expense of wages.
* The growth of interest income can become problematic when the ownership of capital is not evenly distributed. Most capital is in the hands of a relatively small group of rich people that tends to reinvest their capital income instead of spending it.
* As a result other people are not able to buy from their income all the goods and services that capital produces. This helped to reduce the returns on investments so that interest rates could go down.
* This allowed people to borrow more, which propped up the profits of capital at the expense of the future. This meant that interest rates had to go even lower to sustain this scheme. Now interest rates have gone near zero, and if they cannot go lower, there could be trouble.

Banking, central banking and the deregulation of the financial sector helped to bring down interest rates in the following ways:
* Banking provided convenience by making it possible to call in loans at short notice. Banking also reduced risk by making loans to many different people and corporations. Both developments helped to lower interest rates.
* Central banks also helped to reduce risk and lower interest rates. Most loans carry interest, but the money to pay the interest from doesn't exist when the loan is made. This money has to be loaned into existence. Central banks are a backstop when this scheme runs into trouble.
* The deregulation of the financial system further increased convenience and reduced risk. This helped to lower interest rates even further. But lower interest rates and reduced risk also allowed financial institutions to take on more debt and risk.

It may be better to reduce the management of the economy by governments and central banks for the following reasons:
* Under normal conditions central banks set short term interest rates. The public may perceive that central banks subsidise the banking sector by lending at low rates so that banks can make money by borrowing short term and lending out long term. It may be better that markets determine interest rates if possible.
* Government management of the economy has its drawbacks. Government stimulus is not always timed well. And if the economy is doing well, governments often do not build up surpluses. As a consequence government debts tend to grow and can become difficult to handle.

There may be need for a way to reduce the amount of credit and curb risk taking in the financial sector for the following reasons:
* The safety net of central banks can support the profits of private banks. When things go well, bankers can make huge profits and get big bonuses, but when things go wrong, taxpayers may have to pay for the errors that bankers made.
* During economic booms there is optimism, new debts are created based upon a rosy picture of the future, and interest rates rise. The greater the optimism, the higher interest rates can go, but also the greater the bust can be when those higher interest rates turn out to be unjustified. A maximum interest rate could cure that.
* Lower interest rates allow people to go further into debt. Lower interest rates also allow corporations to use more leverage. Leverage can make the financial system and the economy unstable and this can hurt the growth.

If you have any thought on this, I would like to read them. I will try to answer questions.
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2/6/2016 5:05:20 PM
Posted: 10 months ago
Maximum rate of zero on loans?!

That's total lunacy... interest rates are procyclical, and unless I'm reading this incorrectly, this guy seems to want a cap on rates in perpetuity -- or a nominal peg somewhere below zero based on this permanent tax levy on cash holdings. (Btw, taxing cash is actually a really intriguing idea that I'm very much open to as a way of bidding the effective lower bound far into negative territory.)

The remainder of my responses hinge on your clarification to the above.
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2/6/2016 6:35:10 PM
Posted: 10 months ago
At 2/6/2016 5:05:20 PM, ResponsiblyIrresponsible wrote:
Maximum rate of zero on loans?!

That's total lunacy... interest rates are procyclical, and unless I'm reading this incorrectly, this guy seems to want a cap on rates in perpetuity -- or a nominal peg somewhere below zero based on this permanent tax levy on cash holdings. (Btw, taxing cash is actually a really intriguing idea that I'm very much open to as a way of bidding the effective lower bound far into negative territory.)

The remainder of my responses hinge on your clarification to the above.

What do you like to be clarified?

There are a few objections to a maximum interest rate that come to my mind. A maximum interest rate meddles with the market. It caps the supply of credit in the risky segments, but also when the economy is booming, so that the economic boom is curbed and economic booms and busts are mitigated. With a maximum interest rate, it can also be more difficult to borrow long term.

Could you clarify the relation between interest rates being pro cyclical and a maximum interest rate on loans being total lunacy? I am very interested in any issues that may arise from a maximum interest rate.

One of the main problems with low or negative interest rates is that it allows for far more debt to exist, which makes the financial system unstable.

For example, if you have $ 500 per month in free disposable income available for interest payments, you can service a debt of $ 600,000 at an interest rate of 1%, but only $ 60,000 at an interest rate of 10%. If the interest rate rises 2%, your payment increases to $ 15,000 when you have to service a debt of $ 500,000 at an interest rate of 3%, but only to $ 6,000 when you have to service a debt of $ 60,000 at an interest rate of 12%.

And how much debt can you service at a negative interest rate? The answer could be infinite, at least in theory, but not in reality I guess. This also points at the danger of negative interest rates, and the need for measures to curb credit. And a maximum interest rate of zero could do just that. And so it appears that negative interest rates could need a maximum interest rate (of zero).

There is another reason for a maximum interest rate of zero. Compound interest is infinite. Loans are created with the expectation that they are repaid with interest, but the money to pay the interest from doesn't exist, so that it has to be loaned into existence. This is a source of instability and crisis. Central banks are needed to support this system. Under normal economic conditions they add reserves to the banking system to let credit expand smoothly. In emergency conditions, central banks had to buy up debts with currency. With negative interest rates and a maximum interest rate of zero, those problems may disappear.

So, a maximum interest rate clearly has something going for it, and I am very interested in any problems that you may see.
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2/6/2016 6:46:27 PM
Posted: 10 months ago
For example, if you have $ 500 per month in free disposable income available for interest payments, you can service a debt of $ 600,000 at an interest rate of 1%, but only $ 60,000 at an interest rate of 10%. If the interest rate rises 2%, your payment increases to $ 15,000 when you have to service a debt of $ 500,000 at an interest rate of 3%, but only to $ 6,000 when you have to service a debt of $ 60,000 at an interest rate of 12%.

Sorry, I made a typing error. It should be:

For example, if you have $ 500 per month in free disposable income available for interest payments, you can service a debt of $ 600,000 at an interest rate of 1%, but only $ 60,000 at an interest rate of 10%. If the interest rate rises 2%, your payment increases to $ 1,500 when you have to service a debt of $ 500,000 at an interest rate of 3%, but only to $ 600 when you have to service a debt of $ 60,000 at an interest rate of 12%.
ResponsiblyIrresponsible
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2/6/2016 7:05:01 PM
Posted: 10 months ago
At 2/6/2016 6:35:10 PM, Naturalmoney.org wrote:
What do you like to be clarified?

Whether this proposal is for a *permanent* nominal interest-rate peg.

There are a few objections to a maximum interest rate that come to my mind. A maximum interest rate meddles with the market. It caps the supply of credit in the risky segments, but also when the economy is booming, so that the economic boom is curbed and economic booms and busts are mitigated. With a maximum interest rate, it can also be more difficult to borrow long term.

That, and interest rates aren't "set." They're a function of economic fundamentals and the movement of equilibrium rates-- and that's particularly true with long-term rates. You can't exactly cap long-term interest rates unless you are quite literally intervening in Treasury markets and saying, "You can't trade above this rate." That's a price control, and obviously those don't work for the same micro 101 reasons.

Could you clarify the relation between interest rates being pro cyclical and a maximum interest rate on loans being total lunacy? I am very interested in any issues that may arise from a maximum interest rate.

See the above -- it's a price control. Interest rates move with the state of the economy: the neutral rate that stabilizes inflation is an endogenous function of the state of the economy and increasing in NGDP growth. So as the fundamentals improve, as you would expect from an easy-money policy (or relatively easy-money), that neutral rate rises. If you keep the real rate pegged in negative territory, that spread widens, meaning you have persistent upward pressure on inflation. The reason inflation isn't a worry is because of Paul Volcker: expectations of future inflation are well-anchored, but that would soon not be the case with this policy.

Not to mention, you invite a whole host of Neofisherian critiques that normally wouldn't be applicable in a model of the economy with a time-varying equilibrium rate: that is, real interest rates eventually adjust, the liquidity effect is transitory, and eventually inflation moves in the same direction as the movement in the nominal rate, in which case a negative interest rate would actually be *deflationary.* I'm not endorsing this view, but with a peg you invite it as a possibility.

One of the main problems with low or negative interest rates is that it allows for far more debt to exist, which makes the financial system unstable.

I don't buy this "froth" argument generally, but sure it would be a plausible concern with a nominal-rate peg insofar as interest rates aren't able to adjust to increasing perceptions of risks or changes in policy regimes. Indeed, that would result in overly loose financial conditions.

And how much debt can you service at a negative interest rate? The answer could be infinite, at least in theory, but not in reality I guess. This also points at the danger of negative interest rates, and the need for measures to curb credit. And a maximum interest rate of zero could do just that. And so it appears that negative interest rates could need a maximum interest rate (of zero).

I'm not following this at all -- are you capping nominal rates at zero or in negative territory? I read this as capping nominal rates at, say, -1 or -2 and letting real rates move with the fundamentals (e.g., inflation). That doesn't change the overall story that a nominal peg is a really, really bad idea.

There is another reason for a maximum interest rate of zero. Compound interest is infinite. Loans are created with the expectation that they are repaid with interest, but the money to pay the interest from doesn't exist, so that it has to be loaned into existence. This is a source of instability and crisis. Central banks are needed to support this system. Under normal economic conditions they add reserves to the banking system to let credit expand smoothly. In emergency conditions, central banks had to buy up debts with currency. With negative interest rates and a maximum interest rate of zero, those problems may disappear.

This isn't necessarily true either: we're not working within a system of a finite money supply. Emergency liquidity provisioning is only necessary amid an immense shortage or vicious case of maturity mismatch, but assuming a positive net interest margin and a reasonable cash flow from the short end of the balance sheet (deposits), this shouldn't be an issue. This is especially true because a negative policy rate should tend to shift the yield curve upward insofar as markets perceive it as an easy-money policy.
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2/6/2016 7:17:24 PM
Posted: 10 months ago
This is the basic point that I'm making:

Interest rates are a function of the state of the economy, and assuming that inflation and NGDP growth move in tandem, real interest rates and nominal rates would move in the same direction and we wouldn't encounter an issue of multiple equilibria with a nominal rate peg of 0 and a real rate of, say, positive 2 percent. If that's the case, that has implications for investment as well as both current and future NGDP growth.

I see two scenarios:

(a) The Neofisherian approach I highlighted above that John Cochrane and Jim Bullard (president of the St Louis Fed) are sympathetic to, though I don't quite buy it.

(b) The more likely scenario is persistently loose money. If the real interest rate is above that Wicksellian equilibrium rate -- which we could extrapolate, say, from a basic S = I graph -- then that pushes down on inflation and, ironically, down on the Wicksellian rate in which case inflation falls again, real interest rates rise, the spread widens, and we see the cycle continue. The flip side would take place with a real interest rate persistently below this equilibrium level: inflation would rise, the equilibrium rate would rise, inflation and NGDP expectations would rise, the spread would widen, and eventually inflation expectations would become unanchored, in which case this would likely require a Volcker-esque action.

And I'm not normally someone who would ever scream about inflation -- heaven knows we haven't had inflation for an incredibly long time. Given the current persistent shortfall, never did I think I would actually critique a policy for being "too expansionary." Hell, maybe a negative policy rate is merited *right now*, but unless the equilibrium rate is permanently 0 -- and, hell, it might be, and if that's your case, I'm very interested in hearing how you'd rationalize it (global savings glut, demographics, risk aversion, etc.) -- then interest rates need to fluctuate with fundamentals.
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2/7/2016 10:35:10 AM
Posted: 10 months ago
At 2/6/2016 7:17:24 PM, ResponsiblyIrresponsible wrote:
This is the basic point that I'm making:

Interest rates are a function of the state of the economy, and assuming that inflation and NGDP growth move in tandem, real interest rates and nominal rates would move in the same direction and we wouldn't encounter an issue of multiple equilibria with a nominal rate peg of 0 and a real rate of, say, positive 2 percent. If that's the case, that has implications for investment as well as both current and future NGDP growth.

I see two scenarios:

(a) The Neofisherian approach I highlighted above that John Cochrane and Jim Bullard (president of the St Louis Fed) are sympathetic to, though I don't quite buy it.

(b) The more likely scenario is persistently loose money. If the real interest rate is above that Wicksellian equilibrium rate -- which we could extrapolate, say, from a basic S = I graph -- then that pushes down on inflation and, ironically, down on the Wicksellian rate in which case inflation falls again, real interest rates rise, the spread widens, and we see the cycle continue. The flip side would take place with a real interest rate persistently below this equilibrium level: inflation would rise, the equilibrium rate would rise, inflation and NGDP expectations would rise, the spread would widen, and eventually inflation expectations would become unanchored, in which case this would likely require a Volcker-esque action.

And I'm not normally someone who would ever scream about inflation -- heaven knows we haven't had inflation for an incredibly long time. Given the current persistent shortfall, never did I think I would actually critique a policy for being "too expansionary." Hell, maybe a negative policy rate is merited *right now*, but unless the equilibrium rate is permanently 0 -- and, hell, it might be, and if that's your case, I'm very interested in hearing how you'd rationalize it (global savings glut, demographics, risk aversion, etc.) -- then interest rates need to fluctuate with fundamentals.

You have mentioned a few things I will try to investigate in the coming week. I am not a monetary economist, so not all the issues you raise are familar to me. However, I can give a picture of how I see things and why it may be a good idea.

First of all, the proposal isn't expansionary, but rather the opposite. The maximum interest rate would do two things:
(1) curb risky lending as interest is a reward for risk so that taking risk above a certain treshold would not be atractive;
(2) curb lending when the economy is booming because other investments become attractive relative to debt, so that during a boom phase a deleveraging would take place, which makes balance sheets more robust.

Presumably, there is constant deflation, and the rate of deflation could near the rate of economic growth, because money supply and debt could remain constant after some initial changes to adapt to the new system. If the velocity of money accelerates during the transition, which seems a likely scenario, it might be a good idea to undo QE by selling debt from the balance sheets of central banks (and make a profit for the government because interest rates have fallen).

I think that real interest rates will remain low or negative for a few reasons:
(1) the buildup of capital in mature economies may slow down and more and more economies enter this phase
(2) wealth inequality causes excess funds to be available for investment and while there is lack of demand to make these investments profitable
(3) efficient money and capital markets have pushed down interest rates.

My understanding of a boom bust cycle is as follows (and this is at odds with regular thinking). Excess credit can be the result of allowing interest rates to go too high instead of them being too low. When the economy is booming, interest rates rise, and credit becomes abundant. During a boom a lot of debt comes into existence that is bearing high interest rates based on rosy expectations of the future. When the bust sets in, it turns out that these interest rates have been too high.

This appears to make a great case for the maximum interest rate despite the disadvantages. A maximum interest rate can only work if most regular important lending transactions are not hampered by it. During a boom phase more lending transactions would be hindered by the price control, but that can be a good thing.
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2/7/2016 1:09:11 PM
Posted: 10 months ago
I'm not following this at all -- are you capping nominal rates at zero or in negative territory? I read this as capping nominal rates at, say, -1 or -2 and letting real rates move with the fundamentals (e.g., inflation). That doesn't change the overall story that a nominal peg is a really, really bad idea.

The idea is to have a tax on currency (central bank money in bank vaults and cash) of 0.5% to 1% per month and a maximum nominal interest rate of zero. The tax on currency should be spent back into circulation by the government in order to keep the amount of currency constant. A nominal peg can only work if you can rely on the concept being sufficiently deflationary so that the maximum real interest rate is sufficiently high so that it doesn't hamper economic growth in the long term.

That could mean that some types of credit are blocked, for instance:
- credit card debt and consumer credit: if people cannot borrow at high interest rates, effective demand would rise in the longer term after an initial adjustment, so that economic growth would be higher longer term;
- if the economy is booming, and corporations want to attract new capital for new projects, then they may not be able to issue bonds because investors prefer to invest in shares (because of the maximum interest rate) so that they must issue shares. In boom times there would be deleveraging, so that credit induced the boom bust cycle could disappear (any boom would reduce credit, any slowdown would lower interest rates and increase available credit).

I have checked the Neofisherian approach. I was not familiar with this. I don't buy that idea either. First of all, there may be no need for monetary policy any more as the system is inherently stable so that actions of central banks may not be needed. Furthermore, monetary policies tend to follow conditions in the market, and not the other way around. The low interest in Japan for instance is the result of low growth and high savings and raising interest rates would not increase inflation even if the BOJ says that it raises the targeted inflation rate. And as I have written earlier, that the idea of a tax of negative interest rates with a maximum of zero is not expansionary at all, so that this doesn't apply either.

For now, I would conclude that a maximum interest rate is crude price control. Its success depends on the following:
- the number of economically beneficial transactions that would fail versus
- the number of economically harmful transactions that would fail

If the balance is favourable, the maximum interest rate would contribute to economic growth, and thus increase real interest rates via an appreciating currency value, so that there could be a capital flight towards economies that have implemented this idea at the expense of economies who didn't. This might cause this idea to be implemented world wide.
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2/7/2016 4:34:59 PM
Posted: 10 months ago
At 2/7/2016 10:35:10 AM, Naturalmoney.org wrote:
You have mentioned a few things I will try to investigate in the coming week. I am not a monetary economist, so not all the issues you raise are familar to me. However, I can give a picture of how I see things and why it may be a good idea.

Sounds good.

First of all, the proposal isn't expansionary, but rather the opposite. The maximum interest rate would do two things:
(1) curb risky lending as interest is a reward for risk so that taking risk above a certain treshold would not be atractive;

That isn't what happens when interest rates fall, though: there are financial institutions, like money market and pension funds, that would effectively cling to whatever yield they could get. Banks are the same way -- you would actually see them take on MORE risk, at least in the very short term, in order to ensure a somewhat stable cash throw. And, of course, long-term rates would still be in positive territory, so risky mortgages would still exist. The risk factor is more a function of credit spreads than of nominal interest.

Here's a great paper that documents reaching-for-yield behavior in the few years following the onset of the zero lower bound: http://www.brookings.edu...

(2) curb lending when the economy is booming because other investments become attractive relative to debt, so that during a boom phase a deleveraging would take place, which makes balance sheets more robust.

It's true that stocks would be far more attractive if we incorporate a negative nominal discount rate, but the problem is... this isn't just during boom phases: you're talking about pegging the nominal rate, so there isn't any incentive whatsoever to take on debt even when times are bad--you might have some arbitrage in search of yield, but to physically cap the nominal rate, the central bank would need to buy a whole lot of bonds, because the immense cash flows into stocks would tend to push up on nominal interest rates.

Presumably, there is constant deflation, and the rate of deflation could near the rate of economic growth, because money supply and debt could remain constant after some initial changes to adapt to the new system. If the velocity of money accelerates during the transition, which seems a likely scenario, it might be a good idea to undo QE by selling debt from the balance sheets of central banks (and make a profit for the government because interest rates have fallen).

There's... a lot that scares the hell out of me here, lol.

(1) constant deflation?! I mean, I think the opposite is the case given the Wicksellian/reaching-for-yield arguments I made above (though the mispricing of risk in the financial system, which was really what I was getting at, need not coincide with an immense inflationary buildup). The only real mechanism through which this could take place is Neofisherianism, which I don't buy it.

(2) If it's true.... how is that a good thing?! And how exactly are you keeping deflation constant? For deflation to be constant, the nominal rate less the rate of inflation would need to be equal to the Wicksellian natural rate. The starting point with a negative policy rate, because that rate right now is about 0 in real terms, is an expansionary policy that would not stoke deflation. That rate varies over time, so you'd widen the spread in the short run and then it would widen naturally some more as time goes on because it isn't a constant, static rate. So I don't really know how you get to a negative inflation rate, much less maintain it in perpetuity without adjusting the nominal rate.

(3) Even if you got it, how is that positive? I mean, Japan is an example of debilitating deflation with, ironically, a nominal-rate peg at 0. There are immense costs to deflation: generally it's a function of a negative NGDP shock (in your case, NGDP growth in zero, which is a pretty severe NGDP shock if the trend rate is around 4), in which case it hurts employment if prices are sticky; it raises nominally denominated debt burdens which offsets the benefits to servicing debt you cited earlier ; it causes people to delay purchases; etc.

(4) I don't know how the velocity of money would *accelerate* under this system. Velocity, or the inverse of money demand, is an increasing function of the nominal interest rate. You're pegging that rate in negative territory -- so it'll plummet today and remain constant in the future.

(5) Selling QE wouldn't be profitable at all! Lol. QE consisted of purchases of *long-term* bonds, not subject to the short-term nominal policy rate. If current long rates were lower. that might be profitable -- but the main reason long rates are so low is a reduction in term premia: a reduction in supply and expected future supply. Selling them off jacks up term premia and is generally a real... shock to the system. You'd see term premia spike, long-term bond rates spike, a giant hit to inflation expectations, the equilibrium rate would fall (which would make the policy a bit more contractionary over time, but would offset any of the short-term gains of a negative policy rate), etc.

But, really, flooding the market with securities right now, especially when the process of normalization has already made markets incredibly jittery and the global economy is teetering on disaster, really, really scares the hell out of me.

I think that real interest rates will remain low or negative for a few reasons:

I would just say, as a preface, that I agree with this -- I'm generally with Larry Summers on a "new normal" for real interest rates, so if that is the crux of your argument, you won't find much opposition from me. But Larry's proposal obviously isn't to *keep* a nominal peg, but to do things (fiscal policy) that would raise equilibrium rates such that markets could equilibrate at a higher nominal rate. He's worried about.... froth in the financial system. I'm not, but eh, lol.

(1) the buildup of capital in mature economies may slow down and more and more economies enter this phase.

This is true.

(2) wealth inequality causes excess funds to be available for investment and while there is lack of demand to make these investments profitable

Yup. I'm not sure on the magnitude of this effect, but this is certainly true -- though note all of these arguments deal with low *equilibrium rates*, not low actual real rates, though certainly they can nudge real rates up and down (i.e., a global savings glut would tend to cause central banks to reduce real interest rates by more, it would tend to hinder inflation expectations, and that would push down rates on the longer end of the yield curve, etc.).

(3) efficient money and capital markets have pushed down interest rates.

I'm not sure whether I buy this, though it's true that the risk premia has fallen precipitously since the Volcker era in the same way as inflation expectations; so this is probably true.

I have more to say, but am out of space -- so I'll finish responding in another post.
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2/7/2016 4:41:44 PM
Posted: 10 months ago
At 2/7/2016 10:35:10 AM, Naturalmoney.org wrote:
My understanding of a boom bust cycle is as follows (and this is at odds with regular thinking). Excess credit can be the result of allowing interest rates to go too high instead of them being too low.

The big question is why interest rates are so high: if the economy is booming and credit growth is on the rise, it might be possible to raise interest rates fairly aggressively and see term premia/financial conditions ease -- that was the case in 2004, for instance, due to capital flows from China when the Fed tried to nudge rates from 1 percent to 5.25 percent. Generally, I wouldn't buy this argument because higher interest rates are usually a function of the Fed *removing* liquidity from the system -- demand would for credit would, likewise, fall. But credit standards are a far more important variable in this story than interest rates.

When the economy is booming, interest rates rise, and credit becomes abundant.

To raise rates, the Fed removes potential credit from the system -- so I don't really buy this until raising rates is seen as expansionary and financial markets ease as a result (i.e., Neofisherianism), though there's little, if any, evidence for that.

During a boom a lot of debt comes into existence that is bearing high interest rates based on rosy expectations of the future. When the bust sets in, it turns out that these interest rates have been too high.

Depends on the underlying cause of the bust -- I mean, the yield curve turned negative sometime around 2007, so this may not be true. It was certainly the case with teaser loans, but that was more a function of incredibly lax regulatory policy.

This appears to make a great case for the maximum interest rate despite the disadvantages. A maximum interest rate can only work if most regular important lending transactions are not hampered by it. During a boom phase more lending transactions would be hindered by the price control, but that can be a good thing.

I'm not even really seeing the connection here even if I bought the above story on the positive correlation between monetary tightening and credit expansion.
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2/7/2016 4:54:50 PM
Posted: 10 months ago
At 2/7/2016 1:09:11 PM, Naturalmoney.org wrote:
The idea is to have a tax on currency (central bank money in bank vaults and cash) of 0.5% to 1% per month and a maximum nominal interest rate of zero. The tax on currency should be spent back into circulation by the government in order to keep the amount of currency constant.

Okay, I gotcha. But where does the nominal rate end up?

A nominal peg can only work if you can rely on the concept being sufficiently deflationary so that the maximum real interest rate is sufficiently high so that it doesn't hamper economic growth in the long term.

A higher real interest rate and a constant rate of deflation *would* hamper economic growth, though, right? Especially *getting* that rate of deflation would require quelling growth. My first post above goes into detail on how the mechanics of this aren't really feasible.

That could mean that some types of credit are blocked, for instance:
- credit card debt and consumer credit: if people cannot borrow at high interest rates, effective demand would rise in the longer term after an initial adjustment, so that economic growth would be higher longer term;

What's the adjustment? This sounds like price adjustment, which just screammmms Neofisherianism, lol.

- if the economy is booming, and corporations want to attract new capital for new projects, then they may not be able to issue bonds because investors prefer to invest in shares (because of the maximum interest rate) so that they must issue shares. In boom times there would be deleveraging, so that credit induced the boom bust cycle could disappear (any boom would reduce credit, any slowdown would lower interest rates and increase available credit).

The same response I made above regarding how the initial leverage actually takes place applies to this as well.

I have checked the Neofisherian approach. I was not familiar with this. I don't buy that idea either. First of all, there may be no need for monetary policy any more as the system is inherently stable so that actions of central banks may not be needed.

This I *really* don't buy, especially given that real interest rates aren't static and financial markets not inherently stable: if you want a constant rate of deflation, you need a central bank to get out there and maintain it, unstable though that goal is.

But neofisherianism doesn't hinge on the existence of a central bank. You could cut rates once and sit there for 10 years -- the Fed could disband in that time for all John Cochrane cares.

Furthermore, monetary policies tend to follow conditions in the market, and not the other way around.

It's a bit circular -- conditions in the market are based on international events and the Fed, and the Fed is likewise targeting international events and market perceptions of those international events (which is largely a reaction to the market-perceived central bank reaction function). It's one giant, circular mess, but comes down to properly interpreting market signals.

The low interest in Japan for instance is the result of low growth and high savings and raising interest rates would not increase inflation even if the BOJ says that it raises the targeted inflation rate.

Sure, I buy this -- it would lower inflation because their equilibrium rate is somewhere in negative territory. That would then raise real interest rates and choke off inflation again.

And as I have written earlier, that the idea of a tax of negative interest rates with a maximum of zero is not expansionary at all, so that this doesn't apply either.

And as I wrote I don't buy this, lol.

For now, I would conclude that a maximum interest rate is crude price control. Its success depends on the following:
- the number of economically beneficial transactions that would fail versus
- the number of economically harmful transactions that would fail

If the balance is favourable, the maximum interest rate would contribute to economic growth, and thus increase real interest rates via an appreciating currency value, so that there could be a capital flight towards economies that have implemented this idea at the expense of economies who didn't. This might cause this idea to be implemented world wide.

There's a lot that I'm just not seeing here -- how increasing real rates via deflation would be expansionary, how appreciating the currency would *raise* real rates (it would probably do the opposite, both via a reduction in growth expectations and a reduction in term premia), and how currency appreciation would lead to growth.
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2/8/2016 1:44:38 PM
Posted: 10 months ago
[curbing risky lending] isn't what happens when interest rates fall, though: there are financial institutions, like money market and pension funds, that would effectively cling to whatever yield they could get. Banks are the same way -- you would actually see them take on MORE risk, at least in the very short term, in order to ensure a somewhat stable cash throw. And, of course, long-term rates would still be in positive territory, so risky mortgages would still exist. The risk factor is more a function of credit spreads than of nominal interest.

The maximum interest rate of zero would effectively cap the possibility to do so. You cannot get more yield than zero in the fixed income market. There is an exception. For example, a corporation might issue a bond at 0%, and then its prospects could deteriorate, and the value of the bond could fall, so that the yield becomes higher than zero. But bonds yielding more than zero should not be considered investment grade bonds.

(2) curb lending when the economy is booming because other investments become attractive relative to debt, so that during a boom phase a deleveraging would take place, which makes balance sheets more robust.

It's true that stocks would be far more attractive if we incorporate a negative nominal discount rate, but the problem is... this isn't just during boom phases: you're talking about pegging the nominal rate, so there isn't any incentive whatsoever to take on debt even when times are bad--you might have some arbitrage in search of yield, but to physically cap the nominal rate, the central bank would need to buy a whole lot of bonds, because the immense cash flows into stocks would tend to push up on nominal interest rates.

I do not exactly understand what you mean by "pegging nominal interest rates". Presumably, you refer to be it being a price control. The maximum interest rate is zero, monetary aggregates are assumed to be fairly constant, so the interest rate is pegged to the growth rate. What we have observed in recent years, interest rates go down, stocks go up, dividend yields go down.

Whether or not people prefer stocks, depends on the yield and the risk on stocks. Stock are more risky, so in times of trouble their prospects deteriorate, and people tend to prefer fixed income (if a corporation goes bankrupt, bond owners get paid before stock owners get anything). Presumably, there is deflation, so that a yield of zero in fixed income could be a positive real return, and stock prices may trend down longer term. So, I do not expect that to happen.

Presumably, there is constant deflation, and the rate of deflation could near the rate of economic growth, because money supply and debt could remain constant after some initial changes to adapt to the new system. If the velocity of money accelerates during the transition, which seems a likely scenario, it might be a good idea to undo QE by selling debt from the balance sheets of central banks (and make a profit for the government because interest rates have fallen).

There's... a lot that scares the hell out of me here, lol.

It shouldn't scare you because interest rates can go further negative if the economy deteriorates. The deflation we see here is a sign of healthy economic growth. See the holding tax as a constant stimulus. See the maximum interest rate as a lid on credit. The holding tax will prevent recessions. The maximum interest rate will prevent booms. The deflation scare is based on the idea of a depression caused by piles of debt yielding interest that cannot be repaid, combined with a zero lower bound. Maybe you could read Miles Kimball on this. He has the same opinion. Deflation is no problem if interest rates can be negative.

(1) constant deflation?! I mean, I think the opposite is the case given the Wicksellian/reaching-for-yield arguments I made above (though the mispricing of risk in the financial system, which was really what I was getting at, need not coincide with an immense inflationary buildup). The only real mechanism through which this could take place is Neofisherianism, which I don't buy it.

You have to let it sink in. The maximum interest rate would prevent that from happening as I have explained above. It will restrict credit. The search for yield doesn't take place. Who is going to lend when there is a maximum interest rate? If the economy is booming, interest rates go up, and investors prefer equity because of the maximum interest rate on loans and the better yield in equity.

(2) If it's true.... how is that a good thing?! And how exactly are you keeping deflation constant? For deflation to be constant, the nominal rate less the rate of inflation would need to be equal to the Wicksellian natural rate. The starting point with a negative policy rate, because that rate right now is about 0 in real terms, is an expansionary policy that would not stoke deflation. That rate varies over time, so you'd widen the spread in the short run and then it would widen naturally some more as time goes on because it isn't a constant, static rate. So I don't really know how you get to a negative inflation rate, much less maintain it in perpetuity without adjusting the nominal rate.

Ok. I have a time constraint so is the last issue I can deal with today. I have some basic undestanding of the natural rate theory. Presumably, there is some interest rate at which economic growth can be at trend level and inflation can be constant. The natural interest rate may differ from the actual interest rate in the market because the market is influenced by the creation of credit in the financial system. During an economic boom the natural interest rate is above the market interest rate because economic growth is above the trend rate. During an economic bust the natural interest rate is below the market interest rate because economic growth is below the trend rate.

I hope I am correct. I see a serious problem here, apart from the fact that the natural interest rate is just a guess. Interest rates rise in times of optimism because of rosy projections of future revenues [that turn out to be unjustified later], so that interest rates may be too high in times of optimism instead of too low. When the boom is over, it turns out that there had been too much borrowing at interest rates that were too high [considering the outcome], because the expectations of the future were too rosy.

This observation contradicts the theory of natural interest rates in the sense that the natural rate theory suggests that central banks should raise interest rates during a boom. But this would make things worse [even though it will end the boom]. Only a maximum interest rate could stop the borrowing at high interest rates [and prevent the boom from happening, and therefore also the bust]. It also explains why I think that the economy may be fairly stable [stable economic growth, stable credit].

I know that the idea is many ways counter intuitive so that you may not get it right away. It took me seven years to figure it out. Maybe it needs more explanation. I have a website, where you can find a working document that explains the theory as it is now. It is under constant revision as I often discuss this theory on message boards. You can find it via the link below:

http://www.naturalmoney.org...

I hope that I have some more time later today or otherwise tomorrow to reply on the other issues you raised.
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2/8/2016 2:14:34 PM
Posted: 10 months ago
While thinking about it, there is a potential loophole. If the economy is doing better, interest rates rise, bond yields go up, and more bonds may not qualify for being investment grade while the corporation could still be in good shape. It doesn't seem a big problem however, for two reasons:
- corporations can only issue bonds at a maximum interest rate of zero (so under this condition they cannot issue more bonds and need to raise equity if they need financing)
- higher economic growth may increase the real rate (the currency appreciates in a faster pace) and this will compensate for that to some extent.
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2/8/2016 5:59:09 PM
Posted: 10 months ago
At 2/8/2016 1:44:38 PM, Naturalmoney.org wrote:
The maximum interest rate of zero would effectively cap the possibility to do so. You cannot get more yield than zero in the fixed income market.

I know, and that presents other problems -- namely plummeting and, likely, negative net interest margins.

There is an exception. For example, a corporation might issue a bond at 0%, and then its prospects could deteriorate, and the value of the bond could fall, so that the yield becomes higher than zero. But bonds yielding more than zero should not be considered investment grade bonds.

Even then it would get bid down to zero via arbitrage: I can't imagine there being positive credit spreads in this system when there's such a broad-based search for yield.

(2) curb lending when the economy is booming because other investments become attractive relative to debt, so that during a boom phase a deleveraging would take place, which makes balance sheets more robust.

I do not exactly understand what you mean by "pegging nominal interest rates".

You're capping nominal interest rates at zero -- that's a peg.

Presumably, you refer to be it being a price control.

Indeed, that's because it is.

The maximum interest rate is zero, monetary aggregates are assumed to be fairly constant, so the interest rate is pegged to the growth rate.

Monetary aggregates can't be constant in absolute terms unless banks are just not extending credit -- so you must be constant in log terms, right?

Even then I don't buy that assumption because this requires a giant plummet in velocity once you physically slash nominal rates -- and it would probably plummet again to actually hit your desired rate of deflation, as deflation tends to bid down nominal rates across the maturity spectrum, which reduces velocity.

What we have observed in recent years, interest rates go down, stocks go up, dividend yields go down.

I'm aware: I mentioned, I believe, a stock valuation model somewhere above. Of course, this matters a lot on *why* interest rates went down -- if interest rates go down because of horrid fundamentals, a cut in nominal rates triggered by easy money might put a floor under them, but the deteriorating fundamentals will drag them down.

Whether or not people prefer stocks, depends on the yield and the risk on stocks. Stock are more risky, so in times of trouble their prospects deteriorate, and people tend to prefer fixed income (if a corporation goes bankrupt, bond owners get paid before stock owners get anything).

True.

Presumably, there is deflation, so that a yield of zero in fixed income could be a positive real return, and stock prices may trend down longer term. So, I do not expect that to happen.

Stock valuation models don't incorporate real returns as far as I know, so this likely wouldn't be the case -- though, again, somehow getting a rate of deflation at 0 and NGDP growth rate at zero will require incredibly tight money which will probably destroy stocks and push down bond yields.

It shouldn't scare you because interest rates can go further negative if the economy deteriorates.

That assumes you can hit whatever effective lower bound you want, and that the move is seen as credible even after you contract to hit this rate of deflation.

The deflation we see here is a sign of healthy economic growth. See the holding tax as a constant stimulus.

How is a tax on currency a stimulus?

You get deflation in two ways: a positive supply shock or negative AD shock. We have a somewhat positive, though low, rate of inflation now. How do you push it into negative territory? Even with a permanent supply movement -- which would have to be a result of changes in technology or resource utilization, etc. -- prices would eventually adjust. This would require incredibly tight money. Even 0 percent NGDP growth, which is the aftermath of your plan, is incredibly tight money that will tend to push down on employment because prices are sticky. Constant deflation is totally inconsistent with stable growth.

See the maximum interest rate as a lid on credit. The holding tax will prevent recessions.

How?

The maximum interest rate will prevent booms. The deflation scare is based on the idea of a depression caused by piles of debt yielding interest that cannot be repaid, combined with a zero lower bound. Maybe you could read Miles Kimball on this. He has the same opinion. Deflation is no problem if interest rates can be negative.

Debt deflation isn't the only mechanism by which deflation creates self-fulfilling crises. I delineated these above. It's also an issue, though, of how you GET this deflation.

You have to let it sink in. The maximum interest rate would prevent that from happening as I have explained above. It will restrict credit. The search for yield doesn't take place. Who is going to lend when there is a maximum interest rate? If the economy is booming, interest rates go up, and investors prefer equity because of the maximum interest rate on loans and the better yield in equity.

This really doesn't address anything I wrote above as to why this wouldn't be the case, particularly (a) how you actually *get* deflation and (b) the time-varying Wicksellian arguments. Reaching for yield is of far less important than than that, though the extent to which that can occur -- since you're assuming positive credit spreads -- is a function of *credit standards*, not interest rates. Of course banks will lend at a negative rate if the alternative, holding cash, is more expensive: that's the purpose of the tax on currency, which is what I believed Miles Kimball has argued for.

I hope I am correct.

Sounds about right -- somewhat oversimplified in some areas (and it's far more time-varying), but it's enough for our purposes.

I see a serious problem here, apart from the fact that the natural interest rate is just a guess.

It's hard to quantify or observe, but it exists and is the underlying force (if you look at, for instance, unobserved components models) driving movements in inflation and, under a nominal-rate peg, movements in real interest rates (btw, insofar as low returns would discourage credit expansion, positive *real* rates will encourage it.... so this doesn't really combat the "froth in the financial system" argument).

Interest rates rise in times of optimism because of rosy projections of future revenues [that turn out to be unjustified later], so that interest rates may be too high in times of optimism instead of too low.

Depends on what's driving the optimism, but you can see it as an increase in natural rate projections -- i.e., shift in expected path of policy rate, which is driven by central-bank policy.

When the boom is over, it turns out that there had been too much borrowing at interest rates that were too high [considering the outcome], because the expectations of the future were too rosy.

How did rates get too high? That would only be the case if people were shorting financial assets -- the opposite was true if they were too optimistic and thus were underpricing risk.

The biggest problem here is that you're trying to draw conclusions on the aftermath of a price change without considering the underlying mechanism that would achieve those price movements.

This observation contradicts the theory of natural interest rates in the sense that the natural rate theory suggests that central banks should raise interest rates during a boom. But this would make things worse [even though it will end the boom].

Yeah, and they're right, though what they're watching is movement in real rates *relative* to the time-varying equilibrium rate. See above for the rest.

I know that the idea is many ways counter intuitive so that you may not get it right away.

I "get" it -- it's just wrong.
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2/9/2016 10:34:02 AM
Posted: 10 months ago
At 2/8/2016 5:59:09 PM, ResponsiblyIrresponsible wrote:
At 2/8/2016 1:44:38 PM, Naturalmoney.org wrote:
The maximum interest rate of zero would effectively cap the possibility to do so. You cannot get more yield than zero in the fixed income market.
I know, and that presents other problems -- namely plummeting and, likely, negative net interest margins.

Could you explain that? I see it differently. For example, a bank could borrow at -3% from depositors and lend out at 0%. If banks cannot make a profit, they wouldn't exist. And if banks fulfil a useful role, people accept a profit margin. And remember, if the economy grows at a rate of 3%, an interest rate of zero could represent a real rate of 3%, assuming that money supply and velocity are constant.

The maximum interest rate is zero, monetary aggregates are assumed to be fairly constant, so the interest rate is pegged to the growth rate.
Monetary aggregates can't be constant in absolute terms unless banks are just not extending credit -- so you must be constant in log terms, right?
It is indeed true that banks are not extending credit on aggregate, at least in nominal terms. But if the currency appreciates, the real level of credit grows in step with economic growth, so it is somewhat like constant in log terms. That seems not a problem to me. In a positive interest rate environment credit drives economic growth, but in a negative rate environment that doesn't need to be the case, as the stimulus generated by negative rates could replace it. Presumably we have enough capital and we lack demand to make it profitable. Negative rates will make people that have positive balances spend rather than those that have negative balances.

Even then I don't buy that assumption because this requires a giant plummet in velocity once you physically slash nominal rates -- and it would probably plummet again to actually hit your desired rate of deflation, as deflation tends to bid down nominal rates across the maturity spectrum, which reduces velocity.
Negative rates would increase velocity as it is unattractive to keep money. Deflation can only spiral out of control if you have positive interest rates and a zero lower bound so that interest rates cannot adjust to deflationary conditions. If keeping money idle is expensive you have two options: spend or invest. If there is not enough spending, interest rates can go down further, investments can get negative yields so that this will generate a stimulus. Another point I would like to make is that there is no monetary policy so there is no desired rate of deflation.

Presumably, there is deflation, so that a yield of zero in fixed income could be a positive real return, and stock prices may trend down longer term. So, I do not expect that to happen.
Stock valuation models don't incorporate real returns as far as I know, so this likely wouldn't be the case -- though, again, somehow getting a rate of deflation at 0 and NGDP growth rate at zero will require incredibly tight money which will probably destroy stocks and push down bond yields.
I only wrote that fixed income could generate positive real returns. I didn't attribute that to stocks. Credit is tight, there is no doubt about that. The stimulus should come from negative rates.

It shouldn't scare you because interest rates can go further negative if the economy deteriorates.
That assumes you can hit whatever effective lower bound you want, and that the move is seen as credible even after you contract to hit this rate of deflation.
The idea is aimed at getting all available savings to the markets for money and capital (no money under the mattress) so that savings and intended investments will balance. I expect that market forces can solve the problem, so that a central bank has no significant role in this. There is no wanting of me to hit an interest rate or deflation target. You only must keep the holding tax high enough, so that the market is never hindered by the lower bound. This makes the case for a 1% tax on currency per month rather than 0.5%.

The deflation we see here is a sign of healthy economic growth. See the holding tax as a constant stimulus.
How is a tax on currency a stimulus?
In the case of cash this seems quite obvious. A tax of 1% per month stimulates you to spend the money. It works in the same way as inflation. Keeping the money in your pocket is expensive. This also applies to negative interest rates in general. If the economy slows down, interest rates go deeper into negative territory, and you are more inclined to spend.

You get deflation in two ways: a positive supply shock or negative AD shock. We have a somewhat positive, though low, rate of inflation now. How do you push it into negative territory? Even with a permanent supply movement -- which would have to be a result of changes in technology or resource utilization, etc. -- prices would eventually adjust. This would require incredibly tight money. Even 0 percent NGDP growth, which is the aftermath of your plan, is incredibly tight money that will tend to push down on employment because prices are sticky. Constant deflation is totally inconsistent with stable growth.
Sticky prices are a powerful argument against this idea. And I never wrote that this idea has no drawbacks. But in the long run, prices can adjust. You must not focus too much on the tight money aspect as there is also a stimulus. When I discuss this idea with Austrians on Mises, they tend to worry about the stimulus, and the idea being a Keynesian stimulus proposal. Go figure. Keynes himself later admitted that Gesell's idea was brilliant, and he tried to implement it in a SDR proposal.

See the maximum interest rate as a lid on credit. The holding tax will prevent recessions.
How?
If there is a maximum interest rate, and the economy is booming, interest rates in the market rise, so that the maximum interest rate limits credit as less and less people and organisations will qualify, so that the economic boom is curbed before it really takes off. It is a gradual process, so it is not an abrupt end of credit, so that the economy can slow down elegantly. The holding tax can be seen as a stimulus as I have tried to explain.

The maximum interest rate will prevent booms. The deflation scare is based on the idea of a depression caused by piles of debt yielding interest that cannot be repaid, combined with a zero lower bound. Maybe you could read Miles Kimball on this. He has the same opinion. Deflation is no problem if interest rates can be negative.
Debt deflation isn't the only mechanism by which deflation creates self-fulfilling crises. I delineated these above. It's also an issue, though, of how you GET this deflation.
I know that. Presumably, there is no effective lower bound on interest rates if the holding tax is high enough, so the proposal could deal with them too.
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2/9/2016 10:34:58 AM
Posted: 10 months ago
You have to let it sink in. The maximum interest rate would prevent that from happening as I have explained above. It will restrict credit. The search for yield doesn't take place. Who is going to lend when there is a maximum interest rate? If the economy is booming, interest rates go up, and investors prefer equity because of the maximum interest rate on loans and the better yield in equity.
This really doesn't address anything I wrote above as to why this wouldn't be the case, particularly (a) how you actually *get* deflation and (b) the time-varying Wicksellian arguments. Reaching for yield is of far less important than than that, though the extent to which that can occur -- since you're assuming positive credit spreads -- is a function of *credit standards*, not interest rates. Of course banks will lend at a negative rate if the alternative, holding cash, is more expensive: that's the purpose of the tax on currency, which is what I believed Miles Kimball has argued for.
As for (a), deflation basically comes from economic growth and MV=PT. If MV is constant, and T increases, P goes down. So if you start with implementing the holding tax, there is room for interest rates to go down. If interest rates are low enough, you could implement the maximum interest rate. Some people and organisations will not get credit any more and have to adjust (the adjustment phase). The economy is supposed to do well despite of that because of the stimulus generated by the holding tax. If not, interest rates go lower until it does. I have to admit that this transition phase poses some serious questions. I now get why it might be Neofisherian. As for (b) I would need to investigate this more to come to an answer.

Time is up. I hope I have some more time tomorrow.
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2/9/2016 7:55:32 PM
Posted: 10 months ago
I see a serious problem here, apart from the fact that the natural interest rate is just a guess.
It's hard to quantify or observe, but it exists and is the underlying force (if you look at, for instance, unobserved components models) driving movements in inflation and, under a nominal-rate peg, movements in real interest rates (btw, insofar as low returns would discourage credit expansion, positive *real* rates will encourage it.... so this doesn't really combat the "froth in the financial system" argument).
There are multiple forces at play here. First, lower rates allow for more debt to exist. This is more or less a general observation. Second, higher rates allow for more credit to exist. This is more linked to the boom bust cycle.

Interest rates rise in times of optimism because of rosy projections of future revenues [that turn out to be unjustified later], so that interest rates may be too high in times of optimism instead of too low.
Depends on what's driving the optimism, but you can see it as an increase in natural rate projections -- i.e., shift in expected path of policy rate, which is driven by central-bank policy.
Without a central bank interest rates would still rise during a boom, so it is basically a phenomenon that central banks try to manage.

When the boom is over, it turns out that there had been too much borrowing at interest rates that were too high [considering the outcome], because the expectations of the future were too rosy.
How did rates get too high? That would only be the case if people were shorting financial assets -- the opposite was true if they were too optimistic and thus were underpricing risk.
Too high is a value judgement from my part, in the sense that if there is a boom bust cycle, the cause is that interest rates on fixed income instruments during the boom have been too high. As you already mentioned above, low returns would discourage credit expansion, positive real rates will encourage it. So the instability comes from positive interest rates.

That is a mispricing of risk. However this conclusion doesn't lead to a solution. Presumably, risk should be calculated better. But that is as difficult as guessing the natural interest rate. And my analysis is that high interest rates on fixed income products increase risk. So we have a few hypothetical variables that can be subject to misjudgement, aggravated by positive interest rates, and this is the anatomy of booms and busts.

Instead of trying to calculate natural rates and risk, a job at which is difficult for even seasoned economists and central bankers, I would suggest something different, which is the maximum interest rate. That would solve the problem right away, even though it is a price control.

For example, assume there is a project with an expected return of 8% at the time of its inception. Assume that prospects at the time were rosy so two thirds of capital could be borrowed at 6%. Then it turned out that the project only returned 4% and it now operates at a loss and could go bankrupt because of that. Interest rates had gone down to 2% in the meantime, but the interest rate was set in the boom, so it doesn't help the project.

If the maximum interest rate is zeor, it is far more attractive to participate in a project that could yield 8% than to get a 0% guaranteed return. Hence, there is far more investment money available for equity than there is for debt. If things turn out to be different, and returns turn out to be 4%, investors can still enjoy that return. It is not a problem if one project fails because of this, but sometimes this happens at a larger scale, and then we serious problems like the credit crisis.

The biggest problem here is that you're trying to draw conclusions on the aftermath of a price change without considering the underlying mechanism that would achieve those price movements.
Presumably I do not understand all the factors that move interest rates like a seasoned economist does. If you have some interesting links for me to start with (hopefully not too technical), I would like to read them. A maximum interest rate scares off serious economists because it is a price control, and they think that price controls never work. Maybe they are right, but I am not convinced, because the evasive behaviour that it entails, replacing debt by equity, appears beneficial to me.
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2/9/2016 8:08:26 PM
Posted: 10 months ago
There's just... so much mess here, and I frankly don't have much time to really go through this (nor will, at this point), but there are several really key problems here:

(a) Deflation is *not* a sign of economic growth. You get deflation in two ways: a productive boom and a negative demand shock. A productivity boom would reduce inflation in the near term but raise it over the medium term. A negative demand should lead inflation to spiral downward, and positive real interest rates are conducive to that end because a positive real rate would *always* be above he Wicksellian equilibrium rate.

(b) You want to have your cake and eat it too: a zero nominal rate would "restrict" credit -- hint, it wouldn't, because you admitted in your last post that we could manage a positive net interest margin such that banks borrow at -3 and lend at 0, nominally, and given a rate of deflation of 2 percent, they profit -- but also breed a positive real rate of return due to a positive rate of deflation. And supposedly that would inhibit financial imbalances and encourage people to go into stocks... while at the same time not leading to a death spiral of weak demand due to this positive rate of deflation.

There's just so much wrong here, and I'm literally tearing my hair out trying to go through it. There is no real way to think of interest rates other than relative to equilibrium rates, conducive to some trend level of NGDP: even if you manage to somehow anchor inflation expectations at -2 percent, or whatever, which is "equal to the real rate of GDP growth," you get nominal GDP growth of 0 percent. That means you'll be shedding jobs like crazy because wages and price are sticky, and that's going to shift interest rates further downward, shift equilibrium rates downward by more -- driving inflation downward -- and invert the yield curve, such that bank profits will fall off a cliff.

I'm not really interested in going around in circles anymore given my schedule, or devoting even more time to try to think this stuff through. It's just.. not going to work.
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2/10/2016 8:29:42 AM
Posted: 10 months ago
I think you are missing out on something big. We are entering some kind of "economic singularity" in which old theories and ideas will fail miserably. I think that the solution is to have a tax on currency and to set a maximum interest rate of zero on debts (to curb moral hazard and the quest for yield), and that the benefits of this idea outstrip the drawbacks.

As long as serious economists shun the idea of a maximum interest rate because it is a price control, the only thing I can do is to continue the research because I think this is a promising venue of investigation. And the only way of doing that is discussing it with others, and most notably people that don't agree with me.

So, you have helped me a lot. I will most certainly investigate the issues you have raised so that I may have a better idea of the complications we can run into in case this is ever tried out. Up until now I don't think you have made a very convincing argument that it will not work.

In the end, I think that only trying it will confirm whether or not it is a viable idea. And that may only happen out of pure desperation, for example when the economy craters and nothing else works. And I am afraid that that moment is closer than most people think.
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2/12/2016 1:08:57 PM
Posted: 10 months ago
At 2/6/2016 7:17:24 PM, ResponsiblyIrresponsible wrote:
This is the basic point that I'm making:

Interest rates are a function of the state of the economy, and assuming that inflation and NGDP growth move in tandem, real interest rates and nominal rates would move in the same direction and we wouldn't encounter an issue of multiple equilibria with a nominal rate peg of 0 and a real rate of, say, positive 2 percent. If that's the case, that has implications for investment as well as both current and future NGDP growth.

I see two scenarios:

(a) The Neofisherian approach I highlighted above that John Cochrane and Jim Bullard (president of the St Louis Fed) are sympathetic to, though I don't quite buy it.

(b) The more likely scenario is persistently loose money. If the real interest rate is above that Wicksellian equilibrium rate -- which we could extrapolate, say, from a basic S = I graph -- then that pushes down on inflation and, ironically, down on the Wicksellian rate in which case inflation falls again, real interest rates rise, the spread widens, and we see the cycle continue. The flip side would take place with a real interest rate persistently below this equilibrium level: inflation would rise, the equilibrium rate would rise, inflation and NGDP expectations would rise, the spread would widen, and eventually inflation expectations would become unanchored, in which case this would likely require a Volcker-esque action.

And I'm not normally someone who would ever scream about inflation -- heaven knows we haven't had inflation for an incredibly long time. Given the current persistent shortfall, never did I think I would actually critique a policy for being "too expansionary." Hell, maybe a negative policy rate is merited *right now*, but unless the equilibrium rate is permanently 0 -- and, hell, it might be, and if that's your case, I'm very interested in hearing how you'd rationalize it (global savings glut, demographics, risk aversion, etc.) -- then interest rates need to fluctuate with fundamentals.

What he said. Such a wacky plan would cause the boom bust cycle to become more extreme. Perpetual negative rates for bank holding at the Fed means that they would put it at a place other than the fed. Their reserves would be at greater risk where ever they park them. The only way to even execute full controlled of all interest rates including labor and others would be full state control. That is called communism.
Naturalmoney.org
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2/12/2016 3:22:31 PM
Posted: 10 months ago
What he said. Such a wacky plan would cause the boom bust cycle to become more extreme. Perpetual negative rates for bank holding at the Fed means that they would put it at a place other than the fed. Their reserves would be at greater risk where ever they park them. The only way to even execute full controlled of all interest rates including labor and others would be full state control. That is called communism.

(1) Reserves should be held at the central bank (so there is no way of escaping the holding tax on reserves).
(2) It will only work when the market allows it, which means that nearly all interest rates in the market should be negative at the moment of inception (this could happen in the next crisis).
(3) A maximum interest rate would reduce leverage in boom times because it is more attractive to invest in equity.
(4) Removing the zero bound would generate a stimulus in times of recession because real interest rates can go negative.

Presumably, the amount of monetary aggregates (currency and bank debt) could be fairly stable over time, but without any real experiment to prove that, this will be a guess. Anyway, If that is true then economic growth could lead to lower prices and zero interest can be a positive real return.
Chang29
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2/18/2016 11:56:43 AM
Posted: 9 months ago
At 2/6/2016 11:32:22 AM, Naturalmoney.org wrote:
Silvio Gesell proposed a tax on money in his work the Natural Economic Order. His ideas get some attention in recent years because central banks start to venture into negative interest rates. I think there is reason to believe that a tax on currency (central bank money and cash) of 0.5% to 1% per month combined with a maximum interest rate of zero on loans could improve the economy and reduce the number and intensity of financial crises in the future. As a consequence the economy could do better.

A holding tax on currency and a maximum interest rate of zero on loans can have the following consequences:
* the holding tax does not apply on bank deposits and loans so that it can be attractive to lend out money at zero or even negative interest rates;
* the holding tax can help to balance the markets for money and capital at a negative interest rate so that there is no need for stimulus;
* lower interest rates can make more investments profitable and this can help to improve the economy;
* the maximum interest rate of zero can prevent the economy from overheating as there will be less credit when other investments are more attractive;
* the maximum interest rate of zero can reduce reckless lending because there is no reward for taking excessive risk.

Banks can lend out money at a maximum rate of zero so deposit accounts can have negative yields that might amount to -2% to -3% annually. There could be a fixed amount of currency units and there would be a reserve requirement so that there probably is no price inflation. If there is economic growth then the value of the currency can rise because economic growth means that more products and services become available while the amount of money remains the same. So, zero interest rates could actually be a positive real return.

Interest free money didn't work in the past. So why do I think that it might work now? There are a few reasons why I think that might be the case.

The growth of capital helped to bring down interest rates in the following way:
* Throughout history returns on investments have mostly been higher than economic growth. This is unsustainable when most capital income is reinvested because this means that at some point capital income will grow at the expense of wages.
* The growth of interest income can become problematic when the ownership of capital is not evenly distributed. Most capital is in the hands of a relatively small group of rich people that tends to reinvest their capital income instead of spending it.
* As a result other people are not able to buy from their income all the goods and services that capital produces. This helped to reduce the returns on investments so that interest rates could go down.
* This allowed people to borrow more, which propped up the profits of capital at the expense of the future. This meant that interest rates had to go even lower to sustain this scheme. Now interest rates have gone near zero, and if they cannot go lower, there could be trouble.

Banking, central banking and the deregulation of the financial sector helped to bring down interest rates in the following ways:
* Banking provided convenience by making it possible to call in loans at short notice. Banking also reduced risk by making loans to many different people and corporations. Both developments helped to lower interest rates.
* Central banks also helped to reduce risk and lower interest rates. Most loans carry interest, but the money to pay the interest from doesn't exist when the loan is made. This money has to be loaned into existence. Central banks are a backstop when this scheme runs into trouble.
* The deregulation of the financial system further increased convenience and reduced risk. This helped to lower interest rates even further. But lower interest rates and reduced risk also allowed financial institutions to take on more debt and risk.

It may be better to reduce the management of the economy by governments and central banks for the following reasons:
* Under normal conditions central banks set short term interest rates. The public may perceive that central banks subsidise the banking sector by lending at low rates so that banks can make money by borrowing short term and lending out long term. It may be better that markets determine interest rates if possible.
* Government management of the economy has its drawbacks. Government stimulus is not always timed well. And if the economy is doing well, governments often do not build up surpluses. As a consequence government debts tend to grow and can become difficult to handle.

There may be need for a way to reduce the amount of credit and curb risk taking in the financial sector for the following reasons:
* The safety net of central banks can support the profits of private banks. When things go well, bankers can make huge profits and get big bonuses, but when things go wrong, taxpayers may have to pay for the errors that bankers made.
* During economic booms there is optimism, new debts are created based upon a rosy picture of the future, and interest rates rise. The greater the optimism, the higher interest rates can go, but also the greater the bust can be when those higher interest rates turn out to be unjustified. A maximum interest rate could cure that.
* Lower interest rates allow people to go further into debt. Lower interest rates also allow corporations to use more leverage. Leverage can make the financial system and the economy unstable and this can hurt the growth.

If you have any thought on this, I would like to read them. I will try to answer questions.

If there were multiple competing currencies very few people would choose to hold this type of currency, thus just as bad as America's current system.
A free market anti-capitalist

If it can be de-centralized, it will be de-centralized.
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2/18/2016 4:01:17 PM
Posted: 9 months ago
If there were multiple competing currencies very few people would choose to hold this type of currency, thus just as bad as America's current system.

The idea is not to hold a currency, but to consume or invest. If the natural interest rate is negative, then economic growth could be higher if the interest rate is negative, and everybody would be better off. If the economy is doing better, investments would also do better, and people are more likely to invest in the currency.

Remember that an interest-free currency can rise in value because a maximum interest rate would curb credit while the holding tax would stimulate the economy. Equity investments would be preferred to debt, leverage would go down, so that the households and corporations would have a more robust balance sheet. The result could be stable economic growth at maximum potential.

Hence the interest-free currency could rise faster in value than interest accrues on regular money, so that interest-free money could be an attractive investment.
Chang29
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2/19/2016 1:22:49 AM
Posted: 9 months ago
At 2/18/2016 4:01:17 PM, Naturalmoney.org wrote:
If there were multiple competing currencies very few people would choose to hold this type of currency, thus just as bad as America's current system.

The idea is not to hold a currency, but to consume or invest. If the natural interest rate is negative, then economic growth could be higher if the interest rate is negative, and everybody would be better off. If the economy is doing better, investments would also do better, and people are more likely to invest in the currency.

Remember that an interest-free currency can rise in value because a maximum interest rate would curb credit while the holding tax would stimulate the economy. Equity investments would be preferred to debt, leverage would go down, so that the households and corporations would have a more robust balance sheet. The result could be stable economic growth at maximum potential.

Hence the interest-free currency could rise faster in value than interest accrues on regular money, so that interest-free money could be an attractive investment.

If this is such a great idea, your group should be for repealing legal tender laws, so that zero interest rate currency can compete on a free market of currencies.
A free market anti-capitalist

If it can be de-centralized, it will be de-centralized.