Saturday, 21 September 2013

If the US abandoned interest rate adjustments, it would be less indebted to China.

I listed NINE reasons here why adjusting demand via fiscal policy is better than doing it via monetary policy.
But there is one point I missed. And that is that if government issues debt on which it pays interest – and in particular if it raises interest rates when inflation looms  - that just encourages foreigners to buy up some of the debt. And getting indebted to foreigners is not a brilliant idea, unless there is a particularly good reason for doing so. And in this case, there just aren’t any “particularly good reasons”.
Moreover, raising interest rates boosts the value of the relevant country’s currency relative to other currencies, and that is a totally uncalled for, or irrelevant side effect: it just messes up exporters and importers, and for no good reason.
Of course cutting demand via fiscal adjustments ALSO boosts  the currency because fewer imports are drawn in. But there is no good reason for the ADDITIONAL currency boosting effect that comes if demand is adjusted via interest rate changes.
Another point is that if a country issues no interest paying debt and issues just currency (as advocated by Milton Friedman and Warren Mosler) foreigners will doubt less still stock up with a supply of the currency (particularly in the case of the World’s premier currency: the US Dollar). That phenomenon is unavoidable. But there is no need to exacerbate that phenomenon by paying interest to foreigners who hold one’s currency.

1 comment:

  1. Warren's key point here is that not issuing interest on government debt makes the currency harder to get - so it actually firms the price of the currency.

    Raising interest rates shifts the balance towards asset speculators and away from traders.


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