Monday, 14 July 2014

Invest in infrastructure cos interest rates are low?

The above idea was popular during the recent recession. It was advocated amongst others by Larry Summers, The Economist magazine and Jonathan Portes of the NIESR. The idea is tautology, and for the following reasons.

The long slow decline in interest rates.
There are actually TWO REASONS for current low interest rates. First, there has been a very long slow decline in interest rates since the 1980s, and second there is the much faster decline in rates (largely engineered by central banks) since the credit crunch.
But there’s a big problem there for the above “infrastructure enthusiasts”, which is that VAST BULK of the decline in interest rates over the last two decades or so is attributable to the above LONG SLOW DECLINE rather than the faster decline since the credit crunch hit. See chart here, which is reproduced below. (You need to click on the “Max” below the chart that first appears to see the chart reproduced below).

The latter chart shows yields on 30 years bonds rather than 2, 5 or 10 year bonds. But the 30 year one is the relevant one because public sector investments (roads, bridges, buildings etc) last a good 30 years, if not two or three times as long.
Ergo there was no particular reason to up infrastructure investment during the recent recession than in the years just prior to the credit crunch.
In addition, and as I’ve pointed out ad nausiam on this blog, upping infrastructure spending is not a clever way of countering recessions given that it can take years to get such projects up and running – never mind COMPLETING them. Thus any such spending is as likely to stoke the next boom as cure the current recession.
To summarise so far, recent and current low interest rates are mainly attributable to the above long slow decline, so that’s not an argument for infrastructure spending now to any greater extent than it was prior to the crunch. And in any case I’m almost certain the latter slow decline is not what the “spend on infrastrucutre” enthusiasts have in mind: rather it’s the ADDITIONAL drop in interest rates attributable to deliberate central bank policy that they have in mind. So let’s examine that idea.

The engineered decline in rates.
Governments cut interest rates in recessions because they think, for some bizarre reason, that investment spending is a better way of escaping recessions than other forms of spending. The exact reason for that belief is a mystery.
Certainly the lags involved in monetary policy (e.g. interest rate adjustments) don’t seem to be much different to the lags involved in fiscal policy.
At any rate, the big idea is that investment spending is a good way of escaping recessions.  So to effect that idea, governments cut interest rates.
So it’s bizarre, to put it politely, to then say “Oh gosh, interest rates are low – let’s take advantage of that and spend on infrastructure investment”. The reason that’s a bizarre idea is that interest rates are low in recessions PRECISELY BECAUSE governments thinkextra investment is desirable in a recession.
It’s a bit like turning up at a house fire where the fire brigade is already in attendance, and announcing that a good way of putting out the fire would be to use the fire brigade’s hoses to squirt water on the fire.

Jobs for Wall Street spongers.
Another bizarre aspect of the infrastructure argument is thus.
The government / central bank machine cuts interest rates by printing money and buying government debt, i.e. government bonds. And how does it borrow so as to fund infrastructure? Well it does the reverse, that is borrow from private sector entities while giving those entities government bonds in return!!
Now that process no doubt keeps the paper pushers in Wall Street and the City of London occupied, and on handsome salaries. But it would be much simpler to cut out the latter paper pushing and just have government print money and spend it on infrastructure!!
And what do you know? That’s pretty much the policy advocated by proponents of Modern Monetary Theory and by Positive Money.

The free market rate of interest.
Of course it’s possible if not probable that in recessions interest rates tend to fall even absent deliberate attempts by the state to cut interest rates. And if that’s the case, then supporters of free markets like me cannot object to upping investment spending in recessions. But I doubt THIRTY YEAR rates would drop significantly in a recession: everyone knows that in five years at the most (if previous recessions are any guide) the current recession will be over.

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