Monday, January 27, 2014

Sumner engages the crystal ball

Marcus Nunes brings up an old Sumner post. Old Sumner (from 27 May 2009) says interest rates a few years in the future will be either still near zero, or else they will have gone up to maybe 3.75%. Sumner says:

If I looked into the ball and saw 0.25% fed funds rates in 2011, I would have a sickening feeling—like I’d been punched in the solar plexus. Krugman would be right, we’d be another Japan.

In contrast a 3.75% fed funds rate would put a big smile on my face, as it would indicate nominal GDP growth had bounced back strongly. It would have been a V-shaped recovery.

In my view, promising year after year of near zero rates is like promising year after year of sub-par nominal growth.

I get his point. Policy is promising to keep rates low until economic pressures indicate that higher rates are called for. So if rates are still low in the future, it means higher rates are not needed. Sumner would rather they print even more money than they are printing, enough to push nominal GDP up enough that the economic pressures indicate higher rates are called for. Something like that.

Okay? Now, a question: What are the economic pressures that indicate higher interest rates are called for?

Inflation. That's it, really. People borrowing too much and spending too much, creating upward pressures on prices, leading to inflation.

Oh, and since we know that "inflation is always and everywhere a monetary phenomenon", we know that it was all the money created by all the borrowing that allowed all the spending, that caused the upward pressure on prices. We know that much.

Okay, and our plan is to push interest rates up enough to make people borrow a little less, so that there is less upward pressure on prices. That's the plan. Milton Friedman's plan, and Scott Sumner's plan, and maybe Bill Mitchell's plan.

But look what happened in the time between the zero rates and the 3.75% rates: Spending picked up. Spending picked up because the quantity of money increased, because of the growth of lending. So there is more money in the economy, more credit-money, the money created by lending. And there is more interest cost in the economy because of this increased lending.

By the time policymakers notice inflation is picking up, there is already too much of that money in the economy. Must be, right? I mean, if there is already inflation.

So what the policymakers do then is, they slow the further increase of money by raising interest rates. Or, in Bill Mitchell's case, by raising taxes. Now that's interesting, because Mitchell actually takes some money out of the private economy. (Presumably, the government sits on it instead of spending it, so the money stays out of the economy until inflation abates.)

But the other guys don't take money out of the economy. They leave all the money in the economy, even though it was causing inflation, and they raise interest rates. So they don't fix the problem that was making prices go up. Instead they aggravate the problem by increasing the cost of borrowing.

And if they don't do things exactly right, if they slow the growth of money a bit too much, then they create a recession. A "hard landing". We still have our increased interest costs to deal with, and we still have our increased debt to repay. But now we have fewer jobs and fewer people working.

If we do it Mitchell's way, taxing more instead of raising interest rates, then we have less money. But we still have our increased interest costs to deal with, and we still have our increased debt to repay. Mitchell slows growth, too. And he would have to raise interest rates, or people would just borrow the money they need.

I have a different way to fight inflation. I want to fight inflation by getting people to pay back the money they borrowed, faster. My plan is to accelerate the repayment of debt. If we do it my way, we don't aggravate the problem by raising interest rates. If we do it my way we address the problem directly, by reducing the quantity of money created by lending. So we no longer have our increased debt to repay, because we repaid it as a way to fight inflation.

We also reduce the interest we have to pay, which helps to lower costs. But we don't raise interest rates, so we don't choke off new borrowing and we don't kill off growth.


The Arthurian said...

Scott Sumner sees raising interest rates as the right way to reduce inflation. Bill Mitchell sees raising taxes as the right way to reduce inflation. I see paying down debt as the right way to reduce inflation.

Yes, I know, since the crisis we have been reducing our debt. But then, since the crisis, inflation has not been our problem. The trick is to get people to pay down debt a little faster, for fifty years before the crisis. That way, the crisis never comes.

Oh -- and it's not a trick. It's just good policy.

Steve Waldman said...

interesting! do you have in mind a lever (besides interest rates) that policy makers might use to accelerate repayment of debts? would future consumer debt contracts include some indexing to a policy-determined minimum payment or such?

The Arthurian said...

Hi Steve.

The device I have in mind is to let the taxpayer's tax rage vary with his debt-to-income ratio or something like that.

Give taxpayers a tax credit of up to two mortgage payments, if they pay that much extra over the course of a year, Something like that.

The effect I'm trying to achieve is the same effect we get from raising interest rates, but not applied to the whole economy at once. There are probably dozens of ways to do this that are better than the ways I can think of.

The Arthurian said...

Tax rage, yeah, but I meant to type "tax rate".

geerussell said...

Best. Freudian slip. Ever.

Steve Waldman said...

also a very interesting idea, tax incentives to become less levered.

(a bit hard to implement, as there are lots of subtle ways to be in debt; if we're incautious people will refinance formal debt arrangements with less formal arrangements to extract the credit. but then every tax policy needs some sort of verification and enforcement, and all tax policies are gamable and gamed to some degree, but that doesn't render them toothless or useless. it would just require some thought.)

The Arthurian said...

Steve, I am thrilled that you find these thoughts interesting. Two related posts that may add depth and perspective:

The Last Catfish

Infinite Diversity in Infinite Combinations