Monday, October 12, 2015

Interest Rates and the Shadow of the Future

There’s an interesting quote from Axel Weber, one of Germany’s most influential economists, transmitted by Dean Baker this morning:
“When I travel around the world, I find hardly anyone supporting the Fed’s policy on interest rates,” said a senior European official, who did not want to be publicly identified criticizing the I.M.F. “The fund has become very short-term-oriented."
I hear this a lot.  Stimulative monetary policy, in the spirit of the dissolute John Maynard Keynes, is all about living it up in the present and hardly giving a thought to what follows.  Remember Niall Ferguson and the “quip” about Keynes not caring about the next generation because he was gay and wouldn’t have any?

The funny thing is that I am just preparing a lecture on natural resource policy where the central variable, of course, is the discount rate.  Low rates put more emphasis on the future, high rates on the here and now.  And that’s true for all investment, whether in nature, produced capital or human capital.  It’s what r is fundamentally about.  Low r stimulates economies by encouraging more spending on investment.

People who’ve already amassed a lot of money and want to earn a return on it—creditors—like high interest rates.  The rest of us, who either borrow money to invest or depend on a robust economy for jobs and higher wages, see things the other way around.  But in the end, a lower r gives more weight to the future.  It’s about as basic an economic truth as you’ll ever find.


Peter T said...

"People who’ve already amassed a lot of money and want to earn a return on it—creditors—like high interest rates."

This is too simple. What wealthy creditors really want is as iron-clad an assurance of continued payment as possible. Think of C18/C19 Britain - where interest on Consols was around 2-3%. I think it was Galbraith who documented the struggle in the US between high finance, who wanted low rates and hard money, and frontier types who preferred higher rates but softer terms.

Further, Piketty's evidence is that ROI for really wealthy is a near constant 5%. r in the sense of returns to wealth has little to do with funds available for investment.

Peter Dorman said...

Peter T: I go back and forth on this, as previous posts attest. The core empirical question is about the role of equities vs credit assets in wealth portfolios. One could argue that low rates, while reducing returns on the second, increase returns on the first, at least under conditions of insufficient demand. We know that big money is currently all for hard money, but the issue is why.

One way to approach this is to consider that the effect of low interest rates on returns to creditors is direct, but its effects on equities is indirect and mediated. In particular, I think the greater downward flexibility of the wage share in recent decades has weakened the link between effective demand and profitability.

The other approach is through the theory of ideology: it may not be in the case-specific interests of big money to demand hard money, but their ideology compels this. Then we have to explain the ideological mechanism. One thought is that wealthy people think saving is what makes investment and growth possible; it works that way for them. A society, of course, cannot save for future growth; it grows by spending. Keynes understood this deeply; it's his linchpin. When he extols enterprise, he's extolling those who borrow in order to invest. That's why he has always been anathema to the serious money crowd.

Incidentally, from this point of view, there is no meaning to "funds available for investment". Resources yes, funds no. Net savings are determined by investment; they don't determine it.

jed said...

Extrapolating your post very simplistically, maybe rentiers' preferences are focused on short term payoffs. This certainly would explain rentier dominated US fiscal policy -- minimize public investment with long term benefits, maximize short term paybacks. Also to a large extent US regulatory policy -- relatively low consideration of long term consequences of e.g. financial deregulation.

This idea also fits in an amusing way with the most extreme advocates of pro-rentier policy in the House, who seem unable to think beyond their next tantrum.

The more nuanced point you make in your reply to Peter T is also interesting. One way to extrapolate from that is that concentrated wealth will always be generated in ways that differ systematically (and maybe drastically) from overall social wealth. Concentrated wealth will also have (vastly) disproportionate influence on policy.

I don't see that this leads so directly to a short term orientation. But for wealth gained recently in relatively zero sum sectors of the economy it does point in that direction. These sectors would include financial, real estate, and probably gambling. Also, unfortunately for us, zero-sum and short term orientations would motivate investments in corrupting policy, much more than broad positive sum, long term orientations.

kevin quinn said...

Peter: I have always heard that it was Harry Johnson - not Niall Ferguson- who made that nasty comment. And I heard this at least 20 years ago.

According to a teacher I had who was at Chicago when Friedman and Johnson were both there, Johnson whittled. He whittled elephants and joined the trunk of each new elephant to the tail of the previous one in the chain. He called the whole thing "The Chicago School." said...

Oh, I can't resist. Yes, lower discount rates count the future more heavily. However, what should be kept in mind, a lesson from the Cambridge capital theory debates especially regarding reswitching, is that it is not always obvious what policy or project is more future-oriented than another. This come up when things have complicated future streams of net benefits. So, strip mining coal or buidling a nuclear power plant will have high upfront costs followed by a stream of benefit and then high backend cleanup costs (not always counted in actual decisionmaking when it is sometimes assumed that "somebody else" will take care of those). Anyway, when comparing one of those to something with a more or less steady stream of net benefits, such as cattle grazing, one gets reswitching, where cattle grazing may be preferred at intermediate discount rates whereas one of the others (say strip mining of coal which can compete on a piece of land with cattle grazing), can look better at both higher and lower discount rates.

Peter Dorman said...

Barkley, reswitching is not about a (nonexistent) ambiguity about the relationship between interest rates and the future, but a (real) ambiguity about what constitutes "the future" in a complex, interdependent system. But there are contexts in which futurity is well-defined. Natural resource policy (and especially climate change) falls into this category, as does the broad distinction between consumption and investment in the national accounts.

Peter T said...

One way to look at it is to think of wealth as the present value of any monetised income stream. And, broadly, any income stream other than wages is a claim on other persons (to be clear, I do not regard this as illegitimate or exploitative per se). So what the wealthy want, above all, is first to maintain the legitimacy of their claim and second to ensure that their due is paid. In so far as low rates go with greater security of payment, the wealthy are fine with that.

Interesting intersection with your later post - Uber, AirBNB and many more, along with student loans, charter schools and privatisation generally represent a push to monetise new domains. Why? It smacks of a certain desperation.

Bruce Webb said...

“When I travel around the world, I find hardly anyone supporting the Fed’s policy on interest rates,” said a senior European official"

Too revealing by half. Somehow I suspect this 'senior European official' spends more time in First Class Airplane Lounges with convenient connecting flights to Davos, Brussels and St. Moritz and dining in priz fixe two star Michelin rated restaurants than throwing back shots at the European equivalents of the Dew Drop Inn.

We live in a world where, given the right connections, a World Bank/IMF/EU official can travel around the world, including stops in the poorest countries in the world and yet never leave the four star world of luxury hotels, limos, and lunch with the elites.

It goes far beyond epistemic closure, these people might as well by hermetically sealed. It is the flip side of a small town Red State resident who turns from his daily consumption of Rush to get some offsetting "fair and balanced" news from Fox.

People of my age will remember the scene from the Blues Brothers where the bar owner's partner explains to the Boys that this bar plays both kinds of music: Country AND Western.