Tuesday, 12 August 2014
Interest rate adjustment promotes in equality.
The conventional wisdom is that interest rates adjustments should be used to regulate aggregate demand. Positive Money opposes that idea, as do I. I set out numerous reasons for thinking that here.
However, there is yet another defect in interest rate adjustments I’ve just thought of. It’s a bit complicated, but here goes….
Governments borrow for two reasons. One is to fund infrastructure and other investments, and the second is what might be called “non-investment related” borrowing. The latter includes borrowing to fund CURRENT as opposed to capital spending, and borrowing to fund fiscal stimulus.
The idea that government should borrow to fund real investment (the above first reason) SOUNDS SENSIBLE. In fact it is very debatable as to whether that makes sense. See here.
But whether the latter form of borrowing makes sense or not, the important point is that the paragraphs below concentrate on the SECOND reason for borrowing. Put another way, let’s assume no borrowing to fund real investment, or let’s assume the latter form of borrowing is a GIVEN: i.e. that it is a constant.
Put that yet another way, the paragraphs below concentrate on the state AS CURRENCY ISSUER, not on government as “borrower which funds infrastructure etc”.
Now the optimum amount of base money for the state to issue is the amount that keeps the economy at capacity (or “NAIRU” if you like).
Commercial banks may multiply the effect of any base money issuance, but whether they do or not doesn’t affect the argument.
Next, in order to adjust interest rates at all, there must be a stock of government debt on which interest is paid. And to achieve that, the state must issue debt (forgive the statement of the obvious). But what is “government debt”? Well it’s simply a liability of the state. But the state already issues a liability of a sort, namely base money.
So in order for there to be government debt, the government must issue what might be called an “excessive” stock of liabilities. That is, it must issue not just the stock of base money that gives us full employment: it must issue so much that the private sector has to be induced NOT TO SPEND the excess by lending it back to government (at interest).
But it’s taxpayers that fund that interest and a significant proportion of taxpayers are on average incomes or less, while those with an excess stock of base money will tend to be the better off.
So the conclusion . . . roll of drums etc . . . is that the set up that enables interest adjustments to be used to influence demand is one that promotes inequality!