Wednesday, 22 September 2021

Interest rates have been artificially high for centuries.


David Hume in his essay “Of Money” (written almost three hundred years ago) said “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt, will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.”

In other words politicians are always tempted to pay for public spending via borrowing rather than taxes because voters are keenly aware of tax increases, but tend not to attribute any rise in interest rates that might derive from more government borrowing to government or politicians.

Simon Wren-Lewis (former Oxford economics prof) refers to this phenomenon as the “deficit bias”.

Of course the rise in interest rates attributable to government borrowing couldn't be described as “artificial” if that borrowing made sense. For example, it's possible that government borrowing which was confined to funding public sector CAPITAL spending might make sense, though even that is debatable.

One reason for doubting the validity of the “borrow for capital spending” idea is that when any private sector entity, e.g. household or firm, wants to make a capital investment, e.g. buy a new car, and happens to have enough cash to pay for the investment, it won't, quite righly, borrow. Why pay interest when you don't need to?

In other words, the REASON for borrowing to fund capital spending is SHORTAGE OF CASH. But governments are never short of cash in the sense that there is no limit to the amount of cash they can grab off taxpayers, never mind that in most years there is scope for simply printing more money. In short, the “borrow to fund capital spending” idea looks flimsy.

But in any case, the reality is that governments just don't borrow purely for capital spending: they borrow to fund CURRENT spending as well.

So to summarise, a significant proportion of government borrowing, if not most of it, is not justified. Ergo government borrowing results in a artificially high interest rates and has done so for a very long time. Of course the low rates of interest we've seen over the last ten years or so since the GFC and the onset of Covid are an exception, but this article is concerned about the very long term: the last three hundred years or so.

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