Monday, February 4, 2013

The Fed wants us to borrow more

DeLong opens a recent post with these words:

If you have a depressed economy where the central bank wishes to but cannot lower short-term interest rates...

I can stop reading right there. Oh, DeLong has a formula that I can't decipher, and two really good quotes, but I don't need to read all that before I have something to say. My objection arises at his opening thought.

The central bank wishes to lower interest rates, but cannot...

Sure, I can see there might be a problem here. Policy is hindered. But wait:

The central bank wishes to lower interest rates...

Here's where my objection arises. The central bank wishes to lower interest rates. But why? Interest rates are already at the "lower bound". If that's not low enough, there must be some other problem.

What problem? Let's look. The Fed wants to reduce interest rates more, to get people to borrow more. So they are tinkering with the price of credit.

Let's look at the cost of credit.

What is the cost of credit? Is it just the interest rate? Of course not. You don't pay interest unless you borrow some money. So the cost of credit is the total interest payment on all that borrowed money.

If you want to lower the cost of credit, you can do it by lowering interest rates. But of course you "cannot lower short-term interest rates" (as DeLong says) once they get to the lower bound.

So when interest rates are very low, as they are today, if you want to lower the cost of credit still further, you cannot do it by lowering interest rates. You can only do it by reducing the total amount of borrowed money outstanding.

We're doing that, of course. We've been deleveraging since 2008. Or we were, anyway, until we flat-lined in 2010:

Graph #1: Debt Other Than the Federal Debt
And of course, it is largely through the efforts of the Federal Reserve that we stopped deleveraging.

So it looks like 44 thousand billion is the new floor. We're going to pay interest forever on 44 thousand billion dollars -- and more, if the economy ever starts growing again.

It just doesn't make sense.

As of December 2012, there was $3,260.2 billion dollars of spending-money in our economy.

Now look at the debt graph again. Accumulated debt other than Federal debt rises from 41 thousand billion (in 2006) to 47 thousand billion (in 2008), then falls back to 44 thousand billion. That's an increase of 6 thousand billion followed by a drop of 3 thousand billion.

And we have just over 3 thousand billion dollars of circulating money, which is the money we use to pay off debt. So by the numbers, the drop in debt from 47 thousand billion to 44 thousand billion would by itself have been enough to almost entirely wipe out our circulating money.

Why do we have so much debt? More to the point: Why do we think we need so much debt? What the hell is the Fed thinking, that they want to get us borrowing more again?

So, we have 44 thousand billion dollars of debt, and interest rates that are so low we can't get them lower, and we want to get the cost of credit down.

Can you think of a way to do it? I can. I say we stop trying to reduce interest rates, and start trying to reduce debt.

But wait, wait: The Fed wants us to borrow even more.

And this problem arises in the opening line of DeLong's post: in his assumptions. DeLong never bothers to wonder whether the Fed's goal is reasonable.

See the problem?

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