Raise interest rates because in the past they were higher.

I’m getting tired of the argument that interest rates must be raised because in the past, they were higher. This Financial Times article is the latest example of the latter argument.

To be exact, the “17th Geneva Report, commissioned by the International Centre for Monetary and Banking Studies” has according to the FT article “urged governments to use fiscal policy.....to boost investment and raise long-term interest rates” so that come the next recession, interest rate cuts can help deal with the problem.

Well as MMTers have explained, government doesn’t need to pay interest on its debt unless the private sector holds more of such debt than it wants at a zero rate of interest (and zero interest debt more or less equals base money). Thus monetary policy (i.e. adjusting interest rates) is not possible unless there is first an excess amount of fiscal stimulus (i.e. “government borrows and spends and/or cuts taxes”). So a regime where interest rate adjustments are possible is like controlling the speed of a car by having the accelerator (fiscal policy) permanently on the floor, while the car’s speed is adjusted using the brake (monetary policy).

If you’re starting to giggle, so am I. But I’ll continue.

If we ignore the excess CO2 emitted and wear on the brakes and engine that would result from that style of driving, that style COULD MAKE SENSE if the brake is better at fine tuning the car’s speed than the accelerator. Likewise, interest rate adjustments could make sense if they are better at fine tuning. But there doesn’t seem to be evidence that interest rate adjustments actually ARE BETTER at fine tuning. Indeed, several studies show that interest rate adjustments are NOT TOO GOOD at adjusting demand. Thus it’s not clear why there should be a big hurry to revert to “normal” monetary policy, i.e. trying to raise interest rates again.

The exception to that is perhaps the US where anything resembling fiscal policy flexibility is impossible because Congress spends a full year arguing before any change can be made to tax or government spending. However, in most other countries, dispensing with interest rate adjustments and relying just in fiscal adjustments should be possible.

The above Geneva Report also claims that low interest rates encourage asset price bubbles. Well the big problem with that argument is that interest rates have been equally low over the last ten to fifteen years in Germany, Switzerland and Japan, yet according to the Economist House Price Index, there’s been no house price bubble in those countries at all.