Tuesday, 11 November 2014

Why does Adair Turner want higher interest rates?

Adair Turner in today’s Financial Times argues for “money-financed deficits”. I.e. he argues that when stimulus is needed, the state should simply create new base money and spend it, and/or cut taxes.
However, he also argues for a return to the higher interest rates that prevailed prior the crisis. He even refers to the current low rates as a “dangerous subsidy”. His arguments there do not stand inspection.
He does cite a few very obvious advantages of higher rates, like the fact that higher rates would reduce indebtedness. But I can dream up half a dozen advantages and disadvantages of a warmer or colder climate in the space of ten seconds.  That proves nothing.
In contrast, the IMPORTANT question in relation to interest rates, is: what’s the OPTIMUM level of interest rates. As I’ve pointed out before here, 95% of the population, the intelligentsia included, does not seem to understand the concept “optimum”.
So how do we arrive at the optimum rate of interest? Well I suggest adopting a principle widely accepted in economics, namely to assume that market forces bring about the optimum price for anything, unless it’s obvious that the market is ignoring some social consideration.

A free market.
So let’s start with a very simple free market scenario: government spending is a minute proportion of GDP, but government does issue a currency. Now the logical AMOUNT OF CURRENCY to issue is whatever keeps the economy ticking over at full employment. I.e. it’s the amount of currency / money that keeps unemployment as low as is consistent with acceptable inflation (i.e. NAIRU).
But why should government issue SO MUCH currency that there is excess demand and inflation, and government has to borrow some of that money back (i.e. issue government debt) with a view to preventing excess demand? There’s no logic there.
Ergo the state should simply issue enough currency to give us full employment. As to government debt: forget it. And what do you know? That’s exactly what Milton Friedman and Warren Mosler advocate. That is, they argued that the only liability the state should issue should be money, i.e. that the state should not issue debt.

Public investments.
Moving on from the above scenario where public spending is a minute proportion of GDP to a more realistic scenario, namely where a significant amount is spent on public investments, should the state borrow so as to fund those investments? Obviously if the state does borrow, that will push up interest rates.
Well the naïve often think that because an investment is made, money should be borrowed so as to fund the investment. But that’s actually nonsense: if a taxi driver wants a new taxi and happens to have enough cash to buy it, then he or she won’t borrow. (Moral: taxi drivers know more about economics than some economists).
In the case of public investments, the state is never short of cash because it can grab as much cash as it wants from the private sector via tax (or just print the stuff).  Ergo government borrowing makes no sense (or so I’m claiming).
And if anyone cites the argument that borrowing spreads the burden across generations, I’ll demolish that one.

The question as to whether interest rates should be bumped up as a consequence of government debt issued so as to fund public investments is complicated. Turner does not appreciate that point or the complexity.
As to whether the state should borrow so as to fund public investments and thus bump up interest rates, my answer is “no”: and Milton Friedman and Warren Mosler agree with me.
But I’m open to other views.

P.S. One argument for above zero interest rates on state liabilities is that that enables government to adjust demand by adjusting interest rates. That argument would hold if interest rate adjustments were a much better method of fine tuning than fiscal adjustments, but I doubt they are.
Moreover, the mere fact of having the state issue “debt” or “interest yielding liabilities” increases inequalities. That’s because it’s the rich who tend to hold or own government debt, while it’s the average taxpayer that funds the interest payments.


  1. In normal times I agree. But during the war it was necessary to suppress private demand. High tax rates played apart, but when you are asking people to work extra long hours to produce the weapons needed.
    Keynes favored an income tax which would be refunded after the war. But people don't trust government to do that. Allowing them to earn money with which they buy bonds to be paid back when war demand is ended has a similar impact and gives contract security.
    This is a very limited exemption to your rule.

    1. Milton Friedman agreed with you! Word search for "war" here:



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