Thursday, 28 March 2019
Permanent zero interest rates.
MMTers tend to back the permanent zero interest rate idea. E.g. Warren Mosler (and Matthew Forstater) wrote a paper entitled “The Natural Rate of Interest is Zero.” Milton Friedman also said he couldn’t see the point of interest yielding government debt (see his para starting “Under the proposal…”. Plus I set out my ideas on this subject here.
As I explained in my above article, the basic argument against letting interest on state liabilities rise above zero is that full employment can perfectly well be achieved without any such interest rate rise. That is, to get the private sector to spend at a rate that brings full employment, all we need do is issue the private sector with enough base money to spend at the rate that brings full employment. Of course that’s easier said than done, but at least the latter is a simple and powerful theoretical point.
That is, there is no point and no need to issue more than the above amount of base money: if more is issued, then central banks / governments will have to offer interest on that money with a view to inducing the private sector not to spend away what it regards an excess stock of base money. That is, taxpayers will have to be robbed so as to fund the interest, and those who hoard base money will be the lucky recipients of that money. The logic in doing that, to put it politely, is not clear.
Negative interest rates.
The above argument for a permanent or at least more or less permanent zero rate does not however deal with the possibility that negative rates are desirable. So let’s think about that, and we’ll start with an ultra-simple hypothetical economy where the only form of money is base money (notes and coin plus perhaps accounts held at the central bank).
If an inadequate amount of base money is issued, demand will be deficient. That means the central bank will cut interest rates and may try to implement negative rates. But negative rates involve charging everyone and every firm in proportion to their stock of base money: the administration costs of doing that are significant.
Far cheaper, as far as real costs go, is simply to issue the private sector (to repeat) with whatever amount of base money induces it to spend at a rate that brings full employment, and at a zero rate of interest. Creating base money costs nothing in real terms, as Milton Friedman pointed out.
Of course in the real world, fortunately or unfortunately, it’s not just central banks that issue money: commercial banks can do so as well. But that doesn’t make much difference to the above argument. To illustrate, if the amount of money commercial banks can issue is related directly to their stock of base money (i.e. so called “reserves”), then commercial bank issued money replaces some central bank issued money. Otherwise the argument is much the same.
And in fact the amount of money that commercial banks could issue in many countries before the 2007 crisis was actually related to each bank’s stock of reserves. Thus the above simple hypothetical model is far from being unrealistic.
The argument for a more or less permanent zero interest rate is not weakened by the possibility that negative rates are desirable. If anything, the argument for a permanent zero rate is strengthened.