Friday, October 16, 2015

More on Interest Rates, Ideology and Caring About the Future

In a previous post I referred to the economic principle that low interest and discount rates translate into greater concern for the future relative to the present.  At low interest and discount rates you would cut fewer trees, burn less carbon and make more investments in physical and human capital that will pay off in years to come.  If you’re the sort of person who looks ahead and wants to build for the future, you should be for lower interest rates.

It’s interesting that this point, which as far as I know is incontrovertible, is directly contradicted by the presumption of the Very Important crowd that a low interest rate regime is decadent and reflects a live-it-up-now attitude on the part of pandering policy-makers.  How can we understand this?

I suggest that it has to do with the difference between individual and social perspectives on planning for the future.  At the individual level a person can save.  This reduces current consumption but builds up a stock of financial claims that can later be traded in for goods and services: it shifts your consumption into the future.  High interest rates are an inducement to or reward for saving, so being a hard money, high interest rate kind of person shows that you’re a grown up, thinking about the future and not just the passing moment.

But an entire society can’t save for the future.  In a closed system, financial claims have to net out: having a vault stuffed with paper money or paper assets doesn’t make a society any wealthier if they just reflect payments from some people in that society to others.  On the contrary, the future will be better off if we make investments today, and investment is a type of spending, not saving.  Finance 101 tells us that more investment projects will pass our hurdle rate of return or be financed by commercial lenders if interest rates are lower, all other things being equal.

True, in an open system, one with international trade, a country can accumulate financial claims against foreigners and therefore become more wealthy through saving, but this is a small component of wealth compared to the capital stock created by investment, and accumulating an external surplus typically requires a weak currency—which is fostered by, among other things, low interest rates.

So the perspective of the individual saver is a terrible guide to planning for the future, even though it tends to dominate politics.  From a social theory standpoint, this is a nice example of the conception of ideology based on salience.  People with sufficient income to save have to solve the problem of self-control, and the effect of interest as a reward for this virtuous behavior is what stands out to them.  People whose future income depends on making investments today, like students borrowing to finance their education, see interest as the cost of borrowing.  Each view of interest is ideological, in the sense that it generalizes the particular interpretation of a social phenomenon (like interest rates) from personal experience.  It happens in this case that the borrower’s perspective aligns with reality at an economy-wide level, and the saver’s perspective is misleading.


Lord said...

If people do believe in a better tomorrow, they will want to make those investments resulting in increased rates, but some want to believe in reverse causality and that belief makes true, a magical world in which failure is only a deficiency of belief and acting in accordance with it.

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