Friday, July 31, 2015

Borrowing and debt are related, obviously, but they are not the same.

At Reddit, catapultation described the economic process that drives inequality. He showed a graph of the Federal Funds Rate coming down since 1981 and said:

Lower interest rates means increased debt. Increased debt means increased money in the system. That newly introduced money all trickles up, therefore you get the wealthy with huge income increases. It's not rocket science. It also shows why the idea of "increasing demand" is laughable. All you're going to do is increase the 1%'s income by even more. That new money will still just trickle up to them.

I rather liked that explanation. But somebody challenged him on it, making a good (but unrelated) point about interest rates. Catapultation reiterated:

What's misleading about it? Lower interest rates result in more borrowing, yes?

Unfortunately, he made his point two different ways:

Lower interest rates means increased debt.

Lower interest rates result in more borrowing

Those two statements are not equivalent. I agree, yeah, falling interest rates since 1981 were intended to boost the economy, and most of the new money got scooted off into savings (financial wealth). Plus all that debt is also financial wealth and a source of financial income, draining even more cash away from the "nonfinancial" (productive) sector.

Falling interest rates are one reason we did a lot of borrowing. But we have a lot of debt because there are policy incentives to borrow, and policy incentives to be in debt, and there are no policy incentives to pay off debt as fast as we accumulate it.

I said as much. Catapultation quoted me back

because there are policy incentives to borrow, and policy incentives to be in debt

and replied: low interest rates?

Policy incentives to borrow, like low interest rates; and policy incentives to be in debt, like the home mortgage interest deduction and the business interest deduction.

Moreover, the whole of standard policy -- encouraging spending to stimulate growth, but at the same time restricting the quantity of money to fight inflation -- works like a pump, pumping up the use of credit.

1 comment:

The Arthurian said...

Related Post: Making the Wrong Argument.

My point in that post: Private debt holds us down.

In a comment there, Bigvic said: Honestly, I think that private debt is the only thing propping us up.

But then he said this: Where would effective demand have come from these decades without credit. I cannot even begin to imagine where the Aggregate Demand would have been without credit fueling it.

I agree absolutely with that second part: Credit was the fuel for the growth we got. But this does not mean that private debt was the thing that propped us up. Debt is the thing that remains, after we fuel the economy by using credit.

Credit use provides the boost; debt counteracts the boost. Yin and yang.

It is absolutely essential to distinguish credit and its effects, from debt and its effects. Otherwise, we will never solve the problem: We will never even understand the problem.