Wednesday, 31 October 2018

Warren Mosler on the permanent zero interest rate idea.

Warren Mosler wrote a 700 word article in US News a few years go entitled “Federal Reserve Interest Rates Should Be Near Zero Forever”. I agree with the near zero rate idea, but I think his reasons leave a bit of room for improvement. Here’s a summary of his argument.

The 1st para points to various advantages of low interest rates, like cheaper loans for businesses.

The 2nd para says a disadvantage of low rates is that there’s less income for savers, but that doesn’t matter because the cut in demand that that involves is countered by the money that the state (i.e. government and its central bank) injects into the economy by way of interest on government debt.

The 3rd para (starting “The federal deficit…”) says that the deficit also boosts demand.

The 4th para, to quote in full reads, “So this means that when the Fed lower rates, the Treasury pays less interest to the economy on its debt, and that means less income for the economy. In other words, with the economy on balance a big saver, lowering rates removes interest income and therefore acts much like a tax increase, and this hurts the economy.”

Well I’m not sure about that. Interest paid by the Treasury is funded via tax. So if the Treasury pays out $X less by way of interest, then taxes will fall by $X: net effect on household incomes is zero. In fact given that the weekly spending of less well-off households is more closely related to their income than that of better-off households, it follows that a fall in interest rates  (as per the conventional wisdom) will boost demand.

The 5th and 6th paras (starting “Fortunately there are….”) repeats the point that deficits can make good deficient demand.

The 7th para (starting “Additionally…”) advocates the Job Guarantee, or Warren Mosler’s particular version of JG.

The 8th and 9th para (starting “So yes…” ) repeats the above general message that any cut in demand stemming from low interest rates can be made good by a deficit.

And that’s it. 

So to summarise, the basic argument is that any fall in demand caused by low interest rates can be made good by deficits, ergo low interest rates are beneficial. Well now the first weakness in that argument is that it’s widely accepted that a fall in interest rates causes a rise in demand, not a fall, as intimated above in relation to the 4th para.

Second, the fact that deficits can make good the demand reducing effects of A, B or  C is not a brilliant argument for A, B or C. To take a silly example, it would be possible for government agents steal peoples’ wallets and handbags in a random fashion and burn the dollar bills in them. That would cut demand, and no doubt that could be made good, or could be largely made good by deficits.  But that’s not a good argument for burning peoples’ $100 bills in the above random fashion.

Better arguments for a zero interest rate.

There are actually some better arguments for a zero interest rate and as follows.

First, it is widely accepted in economics that the optimum price for anything, including the price of borrowed money (i.e. the rate of interest) is the free market rate. The only exception comes where there are obvious social considerations involved. For example it is widely accepted that education for kids should be available for free. And it is widely accepted that alcoholic drinks should be sold at way above the free market price: i.e. heavy taxes on alcohol are justified.

Second, it is not unreasonable to assume that the free market, left to its own devices, will result in a more or less genuine free market rate of interest in that there are millions of lenders and borrowers out there and hundreds of intermediaries between them. I.e. the market in loans looks very much like a genuine free market.

There are of course some exceptions to that: for example the way in which banks bribe politicians into passing bank-friendly legislation is an exception. But that’s a separate issue with its own solution or potential solution: e.g.  better control of political donations.

Thus the crucial question in relation to interest rates is whether the state (by which I mean government and central bank) is interfering with the above free market rate.

Well I can think of one very significant way in which that interference does take place: it’s the fact that governments borrow astronomic amounts and without any very good reasons. And that will clearly tend to raise interest rates. Indeed, Warren Mosler goes along with that idea: he advocates zero government borrowing. See his second last para in this Huffington article entitled “Proposals for the banking system.”

I actually set out detailed reasons for thinking that the excuses given for government borrowing are nonsense in the second section of a paper entitled “The arguments for a permanent zero interest rate”.


 The state should issue money – base money.

Quite apart from the borrowing issue, one job which the state should certainly do is to issue the country’s basic form of money (Fed issued dollars in the US) in sufficient quantities to keep the economy at capacity, but not in such quantities that excess inflation ensues.

Indeed that function of the state applies even in, for example, a simple economy switching from barter to money for the first time: that is, in any such economy there has to be some sort of central authority that issues the nation’s basic form of money. And in practice throughout history, that function has been performed by kings, rulers and similar.

But it is clearly nonsensical for the latter sort of authority to issue so much money that excess demand and inflation ensues, with the result that the authority then has to impose some sort of deflationary measure like borrowing back some of its own money at interest. That just results in an artificially high rate of interest.

And that is what happens big time in 21st century economies: the state borrows back large amounts of its own money.

Plus don’t be fooled by the fact that the conventional 21st century arrangement is for governments to borrow first, with central banks then creating new money as required and buying back some of that debt. That is just one way of juggling the ratio of the stock of base money relative to the stock of government debt. It would be perfectly easy, as just intimated, to do the money creation first, with government or “the state” then borrowing back some of its own  money as required. Those two arrangements amount to the same thing.

Raising interest rates in emergencies.

Having argued for a zero or near zero rate of interest, it is legitimate to ask which of those two is preferable. Well since there are no good arguments for the state borrowing back its own money, I suggest the answer is “zero except in emergencies”. In other words the objective should always be zero, though clearly if an exceptionally large clamp down on demand is required, then a temporary rise above zero might be justified.

Indeed Milton Friedman advocated much the same, except that the emergency he had in mind was war. I.e. he advocated a zero government borrowing regime, though he thought  government borrowing would be justified to fund a war. See his paragraph starting “Under the proposal…”.


  1. I don't want to over-simplify, but the article of Mosler (or your reading of it) can be syntetized as: "Printing endless money will maximize demand and Job Guaranty promise will be achieved". I would add "and everyone will be rich". I cannot understand how Mosler don't address the risk of inflation (if it is a risk at all) and the measures to deal with it (in case you need to). Because then the dream of endless money breaks, and one returns back to the reality of scarce resources and scarce money.

    1. MMTers like Mosler have said repeatedly that inflation puts a limit on the amount of money creation.


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