Well, of course.  France and the rest of the developed economies are experiencing the same thing.

If the “real” interest rate is negative and has been for a long time, who cares when it finally goes negative nominally?  It’s a non-event, the breathless Drudge headline notwithstanding.

I never see it discussed this way, not even by Steve Keen (be cure to catch the RT/Lauren Lyster video in that post), who I think would appreciate the point:  the negative interest rate environment is a reflection of the political clout wielded by the creditor class.  Central banks don’t dare raise rates because that would diminish the nominal “wealth” of the current creditor class, making the debt they already hold less valuable.

The central bank toadies for the creditor class.  They have to.  That’s part of the problem.

Keeping rates low has nothing to do with “encouraging borrowing”; in fact as the Japanese experience – and now ours – demonstrates, it does not in fact produce borrowing, except by the government, which is as much beholden to the creditor class as the central bank is.  As if there is any real difference.

No, keeping rates negative has to do with preserving the value of outstanding debt.  And it’s very much a trap, because you essentially can’t go lower for natural law reasons, but you can’t go higher for political reasons:  the same people who would get hurt most if you raise rates own the government, and in particular own the central bank.

Zero bound rates under these conditions are nothing but the simple story of how central banks are politicized institutions that should be regarded as such.  Meanwhile, the debt is like a great weight on top of a body that, try as it might, can no longer move.

At some point it will crush us absolutely.



Filed under financial crisis

11 responses to “Stagnant

  1. Andrew MacDonlad

    You’ve got this backwards from several directions – you really ought to take an economics class before commenting on matters like this.

    Low interest rates are a boon to both creditors and potential (and some current – see those with ARMs) debtors. Low interest rates allow banks to receive money more cheaply from the Fed, which then allows them to lend it out more cheaply. This makes credit more widely available to all potential interested debtors. This benefits the bank, which can do more business (lower rates = more customers) and allows debtors to obtain a better deal and makes credit more widely available.

    As evidence of this, just take a look at the current rates for 30 year mortgages: (and compare that to the Federal Funds rate chart; note the correlation:

    So if low interest rates are good for both debtors and creditors (in the short run!), why ever have high funds rates? Inflation is usually the answer discussed in the media, but not the justification for why this is the case.

    One of the accounting truisms of macroeconomics is MV=PY, where M is the money supply, V is the velocity of money (how quickly money is re-spent), P is the price level and Y is the real economic output. An increase in the funds rate effectively takes money out of the money supply, because debtors are less willing to take on debt the higher the interest rates get (which means the bank has more money sitting around collecting dust than out circulating in the economy). This change in the willingness of debtors to accept current rates then affects P, decreasing it (none of these changes, in this simplified model, affect Y).

    Inflation is the hated enemy of creditors and beloved by debtors (as it inflates away their debt). So an easy money policy (=low interest rates) ought to be favored by “the little guys” and a tight money policy (=high interest rates) ought to be favored by banks and creditors more generally.

    Moreover, the federal funds rate has nothing to do with the rate at which federal debt can be sold. Federal debt is sold at auction; a round of debt is auctioned off to whomever will buy the debt at the cheapest interest rate. Federal debt prices are much more closely linked to inflation and the real rates of return in the private sector (i.e. federal government bonds should trade at an equal rate to the risk-adjusted real rate of expected return from other asset classes in the real economy) than to the federal funds rate.

    There are several more errors of economic logic in your post, but I’ll stop here for now as I have some real work to do.


    • Actually, Andrew, you’re not telling me anything I don’t know or am already familiar with. But it’s dogma, not reality.

      The fact is, after (at this point) years of near zero interest rates, bank lending is extremely depressed:

      At what point do we admit that the dogma is wrong, that low rates are partly a reflection of the lack of demand for loans and do not encourage lending or borrowing?


      • Andrew MacDonald

        Of course it is depressed, we are in a liquidity trap. That doesn’t have anything to do with the winners and losers of high vs. low interest rate policy. Banking crises, in general, depress economic activity through the unwillingness of banks to lend money (decreasing V), which then depresses economic activity, which makes banks less willing to lend out money; in the right situation this can develop into a suboptimal stable state equilibrium. There’s nothing radical or outside-of-common-knowledge about this. The tools of the Fed are weak in these situations.

        As for winners and losers of interest rate changes, the political economy remains the same as it always has. It is of no real surprise that the party favoring a tighter monetary policy (=Republicans, who want Ben Bernanke’s head for QEI & II) are also the primary party of creditors; inflation is bad for their major supporters. Likewise, Democrats tend to favor looser monetary policy (=low interest rates, quantitative easing) because their support is primarly drawn from debtors and also Democrats tend to favor full employment at the risk of inflation. It’s been this way since the debates about bimetallism in the 1870s ( and I see no reason why this would change now.

        Your post is also non-responsive about substatiating your claim as to why low interest rates would allow government bonds to be sold more easily. Nor as to how it demonstrates that the Fed is politicised; if anything, the Fed’s structure is set up to favor the creditor class (from which most governors are selected), yet the current Fed, through programs such as QEI & II, Twist and Shout, etc. have angered a great number of them.


        • Hi Andrew.

          I’ve been struggling for a while to get some input from some knowledgeable individual about this seemingly counter-intuitive idea: that lowering interest rates does not encourage borrowing. What I have been speculating is that it is only when potential borrowers anticipate that interest rates will rise that they are then encouraged to borrow.

          Thus as long as rates stay low and the Fed pledges to keep them there – as it has – borrowing will remain in a slump.

          This may be open to question. What is not open to question is that keeping rates low preserves the value of already outstanding debt, at least as compared with raising rates, which would greatly reduce that value, particularly from the near zero bound range where we are now.

          When the Fed keeps rates near zero for years on end and the flurry of supposed borrowing never materializes, yet the other effect – the preservation of the value of existing debt – is of course accomplished because no other result is possible, then which inference as to the Fed’s real purpose is better or more likely?

          See what I mean? What is it that they are really trying to do by keeping rates low?


          • Andrew MacDonald

            I see in part where your confusion is now. You’re assuming that all (most?) debt is adjustable rate, when in fact almost all bank debt is fixed rate.

            Whatever rate the Fed sets only affects new debt being issued going forward, it doesn’t impact any existing debts (well, there are some loans that are ARMs, but they are in the vast minority). So the Fed lowering the rate to 0 and keeping it there doesn’t impact any old debts. The bank gets what you agreed to in some previous period and the current rate doesn’t help or hinder that.

            Furthermore, low interest rates primarly benefit debtors. I mean, think about it for a minute: who pays interest? It is us poor schlubs with home loans and small and medium businesses needing to finance capital purchases and expansions. If we obtain a low-rate loan, that means we have to pay less interest, and can keep more money in our own pockets. I’d go so far to say that the current zero rate environment has been the greatest boon to US homebuyers since the invention of the 30 year mortgage.

            The bank doesn’t necessarily care that much one way or another as to what the interest rates are, as all they are doing is taking a cut of the difference between what they have to pay savers in interest (which is a function of the Fed rate) and the rate at which they loan out the money. You can pick arbitrary savings rates and loan rates and as long as the bank can take their 2-3% cut, they don’t really care what the Fed rates are (except through how the rates influence inflation).

            However, I’m confused as to how keeping interest rates low “benefits existing debt holders.” The one and only thing existing debt holders care about is the expected inflation rate. They have a fixed interest rate note (say, 6%), and a variable inflation rate that will eat away the returns on that note the higher inflation goes. A zero interest rate *encourages* inflation, taking away from the value of that note. A 1% or 2% interest rate, in these economic conditions, strongly discourages inflation, which increases the value of this debt.

            Thus it is no surprise that debt holders HATE the zero percent Fed rate right now, which is why the Republicans want Bernanke’s head. Seriously, think this stuff through before you post, or take one of the many Open Coursework macro classes.

            As to your post about how low interest rate can discourage economic activity, this may be possible if the rate is above zero and potential debtors have expectations that the rates may fall even further. However, once they are at zero, they can’t go any lower. Loans can’t possibly get any cheaper; they can either stay the same price or get more expensive. So there might be some short-term economic disadvantages to lowering the rates, it vanishes once they hit zero.


            • Andrew MacDonald

              Ah okay, after thinking about it some more, I see that you’ve confused the inflation rate with the Fed rate.

              You seem to think:

              Fed Rate Up = Inflation Rate Up = Value of Existing Debt Down

              when in fact, the relationship is:

              Fed Rate Up = Inflation Rate Down = Value of Existing Debt Up

              As it is, the only channel through which the Fed can affect the value of existing debt is through inflation.


              • Actually, no, what I’m thinking of is: if I am a bank and am holding a $100,000 mortgage yielding 3%, and interest rates move up to 6% I have to substantially discount the principal amount of the mortgage to sell it on the secondary market, I’m not really sure but it might be as much as 50%.

                Thus the principal value of my entire loan portfolio goes down in a rising interest rate environment. Same reason rising interest rates are anathema to the bond market, right?


              • Andrew MacDonald

                Ok, now I get where your confusion comes from – you’re confusing the real and nominal interests rates. And introducing the secondary market adds complications, but the story remains the same.

                So let’s say inflation in this example is 1%. If you hold the note on this mortgage, you’re going to get a 2% real rate of return.

                Now, what is the value of the note in the secondary market, if you decided to sell it? That mostly depends on what alternative choices of investment are. If, as in our current situation, there are very few other positive investment opportunities, then a 2% real return seems to be not bad, so the note would be valuable in the secondary market.

                What can affect the “resale” value of the note? One obvious thing would be inflation. If the return on other investment opportunities were held fixed, an increase in expected inflation from 1%->2% would lower your real rate of return on your note from 2%->1%, and decrease the value of your note in the secondary market (this is why debtors hate inflation).

                The other obvious thing would be the attractiveness of alternative investments in the secondary market. What affects their attractiveness? (note here that you can’t “invest” in the federal funds rate, which I think is where your confusion comes from – the fund rate doesn’t impact alternative investment choices). Primarily, the state of the economy, which give two cases.

                a) If the economy is expanding (and so is inflation), then the other asset classes (stocks, primarily) look more attractive and your 2% note not so much.
                b) If the economy is in slow-growth, slow-inflation mode, then your 2% real note looks not so bad.

                Now, what effect does certain changes by the Fed have? Let’s review:

                Interest rate up -> economic activity down (through a decrease in V) -> decrease in inflation (situation b)
                Interest rate down -> economic activity up (through an increase in V) -> increase in inflation (situation a)

                (btw, the bond market usually goes up on interest rate rises, it’s the stock market that goes down – bondholders don’t like inflation, so they benefit from a reduction in presumed inflation, while the stock market likes growth, so they dislike the perceived slowdown in growth that comes from the interest rate hike)


              • I don’t think I’m the one who’s confused here.

                This is not that complicated. There is no need to discuss inflation. Interest rates and bond prices are inversely related. From Wikipedia:

                Fixed rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise. Since the payments are fixed, a decrease in the market price of the bond means an increase in its yield. When the market interest rate rises, the market price of bonds will fall, reflecting investors’ ability to get a higher interest rate on their money elsewhere — perhaps by purchasing a newly issued bond that already features the newly higher interest rate.

                From investopedia:

                So far we’ve discussed the factors of face value, coupon, maturity, issuers and yield. All of these characteristics of a bond play a role in its price. However, the factor that influences a bond more than any other is the level of prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, thereby raising the yield of the older bonds and bringing them into line with newer bonds being issued with higher coupons. When interest rates fall, the prices of bonds in the market rise, thereby lowering the yield of the older bonds and bringing them into line with newer bonds being issued with lower coupons.

                Now, the Fed doesn’t control interest rates in the economy absolutely, but it influences them. Prally not as much as LIBOR, but that another topic.

                Read more:


              • Andrew MacDonald

                No, I don’t think I’m the one confused. This is getting fairly complicated and you have to stay focused on what causes what. This starts to get at some of the interrelationships:

                “Inflation Expectations Determine Investors Yield Requirements
                Inflation is a bond’s worst enemy. Inflation erodes the purchasing power of a bond’s future cash flows. Put simply, the higher the current rate of inflation and the higher the (expected) future rates of inflation, the higher the yields will rise across the yield curve, as investors will demand this higher yield to compensate for inflation risk.

                Short-Term, Long-Term Interest Rates and Inflation Expectations
                Inflation – and expectations of future inflation – are a function of the dynamics between short-term and long-term interest rates. Worldwide, short-term interest rates are administered by nations’ central banks. In the United States, the Federal Reserve Board’s Open Market Committee (FOMC) sets the federal funds rate…”

                So if the Fed raises rates (which, as you linked, lowers the value of *existing* bonds), but because they raised rates, lowers inflation expectations, which effect wins out for existing bond holders? This is actually hard to measure in the long run; short run prices usually “price in” existing inflation expectations but may not price in “surprise” Fed moves. There are a number of research papers to which I could refer you if you were interested in knowing state of the art thinking on the subject.

                So while a raise in interest rate may lower the value of existing bonds relative to new bonds issued, a decrease in inflation (=implied by a Fed rate hike) relative to expectations increases the value of existing bonds at the expense of the debtor.

                So a hike of the interest rate from 0.25% (current) to 1% (which would also presumably decrease inflation) would redistribute wealth in two ways:

                1) From existing bond holders to current bond buyers
                2) From debtors to creditors (=existing bond holders)

                1) Is, at this point, just redistributing money between banks (who hold almost all commercial and much of the government paper)
                2) Screws the little guy at the expense of the banks


              • I’m glad we’ve gotten by the “you need to read baby economics books before you voice an opinion” stage, and are now discussing “research papers” with “state of the art thinking”.

                Clearly, a rising interest rate environment is terrible for bonds on its face, although there may be some countervailing force beckoning that inflation is being tackled, I guess. I doubt that degree of forward looking-ness is too widespread, though. Basically, it’s interest rates up = bonds down.

                I am not advocating raising interest rates and screwing the little guy by any means. And I am not unsympathetic to the central banks’ dilemma, but I’d have to maintain that at bottom what’s driving “policy” is politics, defined broadly. You’re right that creditors are not happy with the way things are. Debtors aren’t either. Right now the path of least resistance is to keep everyone unhappy – but not too much.

                But that situation is unsustainable, and as it deteriorates it’s the people on the bottom who will suffer, albeit slowly, like the proverbial frog being boiled to death.

                The solution has nothing to with interest rates or inflation; it has to do with debt relief, which is the real problem. A jubilee is, of course, a decisive action favoring debtors over creditors. But there is no other way out of a generalized stagnation that will eventually – and who knows when? – implode, but only after years of deadening misery for everyone.


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