Saturday, 17 June 2017

Home buyers have to pay extra interest to enable central banks to control demand.

Reasons for the above are as follows.

There’s a currently popular idea which runs thus. Interest rate adjustments are a good way of adjusting demand, but when interest rates are near zero, there is an obvious problem, namely that interest rates can’t be cut (unless negative interest rates are implemented, and it’s widely accepted they’re a bit dodgy).

Ergo fiscal stimulus should be applied so as to raise demand to a sufficiently large extent that central banks have to raise interest rates to damp down some of that demand. Hey presto: central banks can then cut interest rates come another recession.

For an example of that sort of thinking see the second paragraph of an article by Simon Wren-Lewis (Oxford economics prof) entitled “Could austerity’s impact be persistent”.  In particular, note this passage of his: “a temporary fiscal stimulus can reliably get interest rates off their lower bound.”

Now there’s an obvious flaw in that argument, as follows.

If fiscal stimulus is a “reliable” way of raising demand, why not just use it to an extent that cuts unemployment to its lowest feasible level (NAURU if you like) and leave it at that? I.e. why implement EXCESS fiscal stimulus so that interest rates have to be artificially raised, which of course means that home buyers have to pay an artificially high rate of interest?

And that is the basic reason behind the idea in the title of this article, namely that home buyers have to pay extra interest on their mortgages in order to enable central banks to implement monetary policy – adjust interest rates, etc.

Having said that, there are a number of possible excuses for the latter bizarre policy, and the pros and cons of those excuses are a bit complicated. However it is argued below that those excuses do not really stand scrutiny. So if you want to just get the BASIC message of this article (as contained in the above heading) then stop reading now.

In contrast, if you’re interested in the latter excuses and some of their pros and cons, read on.

Monetary policy works quicker than fiscal?

If interest rate adjustments worked particularly QUICKLY, there might be something to be said for the above “high interest” policy. But according to a Bank of England article, interest rates take a year to have their full effect.

Another potential argument for the high interest rates is that fiscal changes take too long because they have to wait till politicians have spent months arguing about them before they can be implemented. Well that just ain’t true: during the recent crisis the UK cut and then raised the sales tax VAT and all without politicians (apart from the UK’s finance minister) having a say in the matter.

Put another way, it is perfectly feasible to have an element of variability in SOME tax and public spending items (if not all of them) which can be used in emergency, as long as democratically elected politicians retain the right to determine the proportion of GDP going to public spending IN THE LONG RUN. Plus those politicians have a right to determine what proportion of public spending, in the long run, goes to education, law enforcement, defence, etc.

Another argument against interest rate adjustments is that there is no obvious reason why, given a recession, the cause is inadequate lending and investment rather than a fall in one of the other elements of aggregate demand, like consumer spending or exports. Plus even if lending and investment HAVE FALLEN, they may have fallen for perfectly good reasons. I.e. to justify an ARTIFICIAL cut in interest rates it is necessary to prove interest rates have been boosted for no good reason, that is, that they are ARTIFICIALLY high.

Return to “normal” interest rates?

Yet another argument for raising interest rates is that the current low rates are unusual by historical standards, ergo, for unspecified reasons, we need to return to “normal” rates of interest.

Well a big problem with that idea is that quite possibly the rates of interest that have prevailed for the last century or so have not been normal at all: they’ve been artificially high. And the reason for suspecting that is that interest rates have without doubt been boosted by the vast sums that governments borrow.

And that in turn begs the question as to whether governments ought to borrow. Well Milton Friedman and Warren Mosler (founder of MMT) argued that they shouldn’t borrow. Plus Mosler argued that the natural rate of interest is zero – which if correct, means the current low rates of interest are actually the “normal” or GDP maximising rates. (That’s on the assumption normally made in economics, namely that the GDP maximising price of anything is the free market price, unless there are obvious social reasons for thinking otherwise.)

This is a complicated issue, but I suspect the clincher argument for thinking government borrowing is unjustified is thus.

Government facilitates lending and borrowing.

Government borrowing is effectively just a way of giving people a choice as to how they pay for public spending: that is, instead of everyone paying up front, some people can pay relatively little, and instead, pay interest (via tax) to those who pay MORE THAN their “upfront” amount. (The people who pay more are who buy government debt/bonds).

Thus in effect, government borrowing is a grandiose scheme which enables those with cash to spare to lend to those who want to borrow. But would be lenders and borrowers are free to lend and borrow to each other ANYWAY! So why the need for a special government scheme to facilitate the process?

It could of course be argued that government borrowing makes the latter process easier: it enables lending to take place at a lower rate of interest than would otherwise obtain because government bonds are totally secure, plus government is a very efficient debt collector (collector of debts from those who owe interest / tax). But that efficiency of government relies on the coercive powers that government has: e.g. if government needs to repay its creditors, it can simply grab money by force off taxpayers.

In contrast, those who lend to fund genuine free market loans (e.g. for a mortgage) do not enjoy the same coercive powers. For example a normal creditor can grab property off debtors, but the creditor cannot send the debtor to prison. Nor can a normal creditor grab money off the population at large via tax.

To summarise, government borrowing does amount to a grandiose scheme under which those with cash to spare can lend to those who want to borrow, but there is no justification for that government intervention in the “lending and borrowing” market.

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