Dirk

From Gang8:

Re: [gang8] Back to interest rates

Chris,

I agree that savings and borrowings are an identity at all points indeed but frankly that does not address the issue. That equality is the case for ALL demand and supply in markets that clear (as all markets do by definition in the perfect-competition model), so that argument won't convince believers in that model (aka economists). What you need to show is that saving/borrowing do not vary inversely with interest rates.

In a 2006 paper I researched this issue and found that NO published academic article convincingly shows that higher (lower) interest should decrease( decrease) lending/borrowing. It's an assumption. I wrote:

And indeed “the intuitive feeling with regard to the importance of the rate of interest for credit … is seldom found in empirical econometrics.” (Fase, 1993:99). Lown and Morgan (2006) show that loan volumes dominate loan rates in explaining output. Geanakoplos (2009:9) recently called in Nature for an end to “the obsession with interest rates” and asserts that “regulating leverage, not interest, is the solution for a troubled economy”. Malcolm Knight, General Manager of the Bank BIS noted in a 2006 speech: “The prevailing mainstream theoretical paradigms, enshrined in current textbooks and research, find it difficult to accommodate a significant role for quantitative aggregates over and above that played by interest rates”.
The widespread practice of reducing the study of credit markets to interest rate or credit spreads relies on the perfect-market assumption that prices reflect all information - completely unwarranted in a market which, as Richard has argued, are quantity-rationed by the supply side (banks) due to information asymmetries.

Dirk

"The widespread practice of reducing the study of credit markets to interest rate or credit spreads" is the reason nobody saw the crisis coming. Nobody was looking at the big picture. Nobody was looking at accumulating debt.

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"What you need to show is that saving/borrowing do not vary inversely with interest rates."

Interest rates go up and down in a cycle that essentially duplicates the business cycle. The accumulation of "saving/borrowing" goes up and down in a cycle that essentially duplicates the long wave.

There are many business cycles in a long wave. There are many ups and downs of interest rates in one long upswing of debt accumulation. Saving and borrowing do not vary inversely with interest rates.

Or maybe Dirk is talking about new additions to saving and borrowing, as opposed to total accumulations. If so, he is concentrating on a very small part of the problem.

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“The prevailing mainstream theoretical paradigms, enshrined in current textbooks and research, find it difficult to accommodate a significant role for quantitative aggregates over and above that played by interest rates”.

Economists say they need a new "paradigm" but evidently they don't mean it. Dirk and the BIS guy he quoted have pegged the problem.

The thing of it is, when you put finance people in charge of policy, they just can't see debt as a problem.

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"...completely unwarranted in a market which, as Richard has argued, are quantity-rationed by the supply side (banks) due to information asymmetries."

Quantity-rationed? Dirk makes it sound as if there is a shortage of available credit. Maybe so, since the crisis. Certainly, before the crisis there was not.

I think Dirk is looking at new issue of credit, as opposed to the total accumulation of credit in use, or total debt. It's the same problem he and the BIS guy observed. The accumulation is the problem. It is a cost burden. And it "crowds out" new borrowing. Only when we pay off a dollar of debt does that dollar becomes available to lend again.

When there is economic slowdown, very likely there is a decline in new lending. But there is no automatic decline in outstanding debt. That's how we get into trouble. And then, with the slowdown, outstanding debt becomes even more unaffordable. That's how we get into crisis.

Dirk is concerned about credit-rationing by the supply side. My concern is completely different. I want to see less DEMAND for credit. I want to establish policies that reduce the demand for credit but provide interest-free money to make up the difference.

I want less TOTAL demand for credit, but not less NEW demand for credit. New uses of credit help the economy grow. Old accumulations hinder growth. Both new credit-use and old outstanding debt are part of the total demand for credit. If the total demand for credit is too great, then we must reduce new credit-use, or we must reduce old outstanding debt, or both.

Existing anti-inflation policy reduces the demand for new credit-use, thereby creating an impediment to growth.

Arthurian anti-inflation policy reduces the demand for old outstanding debt, thereby removing an impediment to growth.