By Philip Pilkington, a journalist and writer living in Dublin, Ireland
Warren Mosler recently ran a very succinct account of why the Fed/Bank of England’s easy monetary policies – that is, the combination of Quantitative Easing and their Zero Interest Rate Programs – might actually be killing demand in the economy.
Mosler’s argument runs something like this: when interest rates hit the floor they suck interest income payments that might flow to rentiers and savers. And no, we’re not just talking about Johnny Moneybags refusing to buy his daughter a new Prada handbag (which, say what you will, creates job opportunities). We’re also talking about regular savers and, as the Fed recently noted, pension funds seeing their income fall – not to mention certain industries, like insurance, finding their profits lowered (and hence their premiums raised?).
Mosler sums it up well:
Lowering rates in general in the first instance merely shifts interest income from ‘savers’ to borrowers. And with the federal government a net payer of interest to the economy, lowering rates reduces interest income for the economy.
He then goes on to make the point that we’d have to see borrowers spending more than savers to see any real stimulative effect on the real economy. But alas, such is probably not the case.
The only way a rate cut could add to aggregate demand would be if, in aggregate, the propensities to consume of borrowers was higher than savers. But fed studies have shown the propensities are about the same, and, again, so does the actual empirical evidence of the last several years. And further detail on this interest income channel shows that while income for savers dropped by nearly the full amount of the rate cuts, costs for borrowers haven’t fallen that much, with the difference going to net interest margins of lenders. And with lenders having a near zero propensity to consume from interest income, versus savers who have a much higher propensity to consume, this particular aspect of the institutional structure has caused rate reductions to be a contractionary and deflationary bias.
In her seminal book The Accumulation of Capital – truly a forgotten classic of 20th century economics, right up there with Keynes’ General Theory – Joan Robinson trashes out the implications of falling interest rates. Of the investor she writes:
If he has been successful in the guessing game (on the advice of his broker or backing of his own fancy) and made [investments] which have risen in price so that his capital has appreciated, he has to debate with his conscience whether he has a right to realise the appreciation and spend it, and his decision turns very much upon whether he may expect similar gains in the future, so that they are properly to be regarded as a continuing income.
The point that Robinson is making is that investors have a peculiar morality – she calls it a ‘peasant morality’ – which leads them to separate in their own mind their capital and their income. Investors tend to prefer to spend based on income – that is: dividends, interest etc. – and preserve their capital intact. It’s a bit like the drug dealer’s street wisdom: “Never get high on your own supply”. Spending out of capital – even if this capital has accumulated in the short-to-medium run – is seen by the investor as being somehow immoral. And for this reason investors tend not to dip into their outstanding capital lest their net worth fall as a result.
Robinson then goes on to make a point that would certainly resonate with bond traders today who are, due in large part to the Fed and the Bank of England’s easy monetary policies, seeing value increase and yields (which are essentially interest income) fall.
If the value of [the investor’s] holdings has risen, not because of his personal skill as [an investor], but because of a general fall in the level of interest rates which is expected to be permanent, he is faced with a different problem. For the time being his receipts are unchanged and the value of his [investments] has risen, but, unless all his holdings are in very long-dated bonds, or in shares in whose future capacity to pay dividends the market has great confidence, he will later have to replace money at a lower return, so that his prospect of future income has fallen.
Robinson’s point is that in the investor’s mind his income has fallen. And such a fall in income leads him to retract consumption spending. This leads, as Mosler points out, to a dampening of effective demand in the economy.
It also, I should think, affects investor psychology in that a lack of future income leads them to see the future as being all the more bleak. Their prospect of future income having fallen, this could well lead to a far greater propensity to hoard. It could also make investors more edgy as they try to preserve their capital in what has come to seem like a very uncertain environment. This could lead them to seek out what they think to be safe investments – such as gold and other commodities – thereby inflating bubbles that further exacerbate consumer spending power.
Monetary policy is a slippery beast indeed. But it has become the mantra of the day. For many central bankers, whom I have no doubt go to bed at night dreaming that their governments would initiate stimulus programs, it is all they have. That said, they should really take a look at the facts and not assume simple causal relations that may hold good (to some extent) some of the time, but by no means hold good all of the time.
Yet, the internet commentariat continue to call for more ‘innovative’ monetary policy. A good recent example of this is Clare Jones over at the FT:
What’s clear already though is that, unless the Fed opts to give more quantitative easing — or something more radical — a try, there’s little else it can do to lower the cost of borrowing.
Analysts need to drop their preconceptions. There are very few hard and fast causal relations in capitalist or any other economies. These economies are constantly changing and as they toss this way and that causal relations alter and break down. To try to come up with simple rules to understand the workings of an economy is to excuse oneself for giving up on actually thinking things through.
In truth, negative real interest rates – which, I believe, is what Jones is alluding to – even if they could be implemented (which I don’t believe they can), would be rather dangerous in the current environment. They would likely lead to more hoarding behaviour as investors became ever more nervous about the future. Its expansionary fiscal policy we need. Strong-armed expansionary fiscal policy. There is no alternative.