Why zero interest rates are here to stay

by John Quiggin on November 14, 2020

That’s the self-explanatory title of my latest piece in The Conversation. It’s wonkish, but important. As I’ve explained here and here, an economy with zero real interest rates works very differently from the kind we are used to.

{ 23 comments }

1

Hidari 11.14.20 at 11:12 am

This is not exactly relevant (I know that a situation where you don’t pay interests on loans doesn’t equate to ‘free money’…you don’t have to pay it back, although in a world of inflation, even very low inflation, where interest rates are literally zero, you are essentially being paid to borrow), but still does seem relevant to a situation where some things are literally free, as is frequently the case in late (or early) capitalism.

‘ let’s go back and look at (the question): ‘what is Utopia?’. I will use Marx’s definition given in the “Critique of the Gotha program”: Communism is the situation where “the productive forces have increased with the all-around development of the individual, and all the springs of co-operative wealth flow…abundantly—[so that]…the narrow horizon of bourgeois right [can] be crossed in its entirety and society inscribe on its banners: From each according to his ability, to each according to his needs!”. Utopia is thus a situation where goods and services are absolutely plentiful, there is no scarcity, and we can take as much of them as we like.

Now, some may stop me right there: this will never happen, they will say. But not so fast. Notice that when I go to my local Starbucks I have already entered a bit the “coast of Utopia”. I can get there an unlimited quantity of water, ice cubs, water cups, paper napkins, honey and milk, all for free. They are all laid out for all customers (and even for those who are not customers but just walk in) to take in unlimited amounts. There are other goods that have almost entered this cornucopia in our lifetimes: water, electricity. When I need to recharge my laptop I can count on getting free electricity from practically every store, train, or airport. There are of course other services like museums and open-air concerts that one can enjoy for free but they are a bit different because somebody else has paid for them. But I want to mention it here because we shall find them useful in a moment.

So, there is, I think, already now a limited, but growing, number of goods and services whose marginal cost of production is so low that they are practically free. (The average cost of production is not zero, but to an individual consumer these goods appear as free.) Consider now the behavior of people. Do they go to Starbucks stores and fill their pockets with free paper napkins or grab free ice cubes? No. Do they go to free open-air concerts day after day and fight for the spots? No. Once you know that such goods will be plentiful and free, you do not keep an unreasonable stock of them, nor do you fight to get them. You know they will be around when you need them.

So far we have I think made two important conclusions: there are goods that fall into the category of “Utopian goods” and behavior that people exhibit towards these goods does not include hoarding, wanton destruction or wastefulness.

Can we imagine that with economic progress more and more goods begin to fulfil this condition of Utopian goods? I think we can. Surely 40 or 50 years ago, you had to pay for the smallest piece of paper or paper napkin, not get it for free as now. (There is still a difference between the US and Europe in this: European Starbucks stores make it more difficult to get free paper napkins.) You even had to pay for a cup of water in an inn on a dirt road. Not today. So perhaps one day we shall walk into a Starbucks store and be given as much coffee for free as we like in the expectation that we shall buy some other, new fanciful product. But notice that when this happens, coffee will have joined paper napkins and ice cubes on our list of Utopian goods. So the list will be growing.’

And so on.

http://glineq.blogspot.com/2015/09/99-percent-utopia-and-money.html

2

MisterMr 11.14.20 at 1:01 pm

There are also other explanations:

1) the the market is pricing in a deflation, so interest rates aren’t really negative;

2) businesses don’t invest because they don’t expect demand to pick up, so there is no point in investing in additional capacity, so excess savings end up in rentier capital goods;

3) expectd savings are just too high for the “real” economy to absorb them.

There is also this thing about savings VS the real economy, that there is a sort of assumption that the savings/gdp ratio should be a constant. But if it isn’t then there is no reason for total savings to increase much faster than nominal gdp, that either implies a fixed interest rate to eat larger and larger shares of gdp ot to the interest rate to fall over time; furthermore if it is natural for the amount of savings to grow faster than income then the value of capital goods has to increase relative to that of consumption goods, and this can happen only with an increase in price of rentier goods.

3

Dave Heasman 11.14.20 at 4:57 pm

It’s “Steven” Kennedy. I looked it up to check which country he was Treasury Secretary of.

4

Rapier 11.14.20 at 5:23 pm

All this zero rate stuff is OK as long as one is ignorant of the mechanisms of money creation. For instance soverign debt interest rates have fallen to zero nominal and actually below zero in the stated rates in Europe because Central Banks have created about $25 Trillion dollars to ‘lend’ to governments since 2003. I use the ironic quotes because no government is ever going to pay much of the principal back.

https://www.yardeni.com/pub/peacockfedecbassets.pdf

I suppose one is free to call money creation by edict “savings” if one is of the Kellyanne Conway school of alternative facts and why not? Greenspan and Bernanke always did and they are the high priests of money. Just because money suddenly appears as bank deposits doesn’t make it savings.

5

Hidari 11.14.20 at 6:11 pm

To change the subject entirely: how can you search CT OP’s by date?

I remember that at some point in the few days’ after Trump’s election, someone (I can’t remember who) wrote an incredibly insightful OP about Trump on CT (I think whoever wrote it was a political scientist but I can’t really remember) and now, since I have forgotten their name (it wasn’t one of the usual commentators) I can’t search for it.

6

John Quiggin 11.15.20 at 1:47 am

@Rapier I’m having an Austen Powers moment here. A trillion dollars or so (the annual increase in central banks assets) isn’t a lot of money in the context of a global economy with annual output of $90 -150 trillion (depending on how you measure it). It’s enough to keep short-term rates negative, but not to shift the long-term balance between investment and savings.

https://crookedtimber.org/2020/07/18/a-trillion-here-a-trillion-there-pretty-soon-youre-talking-real-money-creation/

@Hidari We used to have an archive in the sidebar, I think. I’ll see if it can be added back.

7

SamChevre 11.15.20 at 2:44 am

@hidari

You can hand-edit the url to access the archives: https://crookedtimber.org/2016/10/ will show you the post from October 2016.

I suspect the post you are remembering is:
https://crookedtimber.org/2016/11/15/on-the-national-and-international-causes-of-trumpism/

8

bad Jim 11.15.20 at 5:13 am

It’s raining soup, and the powers that be are wielding forks.

9

Zamfir 11.15.20 at 6:13 am

@Rapier, the money printing is more effect than cause, I think? All that extra money, and inflation is still historically low.

10

Hidari 11.15.20 at 11:45 am

@7
That was precisely the article I was looking for. Thanks!

11

MisterMr 11.15.20 at 2:04 pm

@Rapier 4

Well yes, if I want to stash a 100$ banknote under my bed, someone must have printed it before I can save it.
The same goes with bonds, so government emitting bonds in their own currency is the same of them printing money.
But since we are at it, most savings are meny “created” by banks (in this acception, created =bank lend to someone while accrediting the same money on someone’s else deposit).

But this doesn’t change the problem: apart from the fact that most of themoney is “created” by banks, it still is the case that governments in, like, the last 300 years or so(*), had to consistently uphold a government deficit (spending more than what they get in taxes) to keep the economy running.
So the question is: are government forced to pursue expansionary policy because of a saving glut/tendency to underconsumption, or are the savings created by government policy?

Does A cause B or does B cause A?

In my opinion, it is the private economy that tends to create a lot of money through banks(**), but this money creation is pro-cyclical, so when the economy goes down governments have to step in printing a lot of money and substituting the banks in ths role. But this only makes sense if we assume that the economy is normally in a situation of saving glut/tendency to overconsumption/capital overaccumulation/whatever (these are all different names for the same phenomenon).

(*) at best of my understanding, this already happened during the gold standard era, the USA had to drop the gold standard because the government wanted to run bigger deficits, but the deficits already existed before.
(**) this I’m certain that happened during the gold standard and well before, since the late middle ages, and in facts central banks were created to limit overlending by private banks.

12

eg 11.15.20 at 3:37 pm

I was pleased to note that the linked article references the Bank of England paper tracing the long secular decline in interest rates since the 14th Century

I strongly recommend it to anyone who hasn’t read it

https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2020/eight-centuries-of-global-real-interest-rates-r-g-and-the-suprasecular-decline-1311-2018

13

Rapier 11.15.20 at 4:30 pm

@John Quiggin

$20 Trillion mainlined directly into the financial markets since the advent of the crisis of 07/08 is a hugely significant amount of money. The mechanism by which central banks inject money into the economy are of paramount importance. Central banks create the money and deploy it in one place. That is purchasing financial assets from the global banking giants and their customers which in turn inflates the price of financial markets.

To wit, Total US stock market capitalization vs GDP
https://pbs.twimg.com/media/Emt0VKMXEAID-HT?format=jpg&name=900×900

Of course the largest effect has been on interest rates as that is where the bulk of the central bank purchases have been. So what most are sure to ask. Aren’t low interest rates good for everyone? Everyone knows low interest rates spur growth.
https://pbs.twimg.com/media/Em0XbvdXYAM0N7n?format=jpg&name=900×900

Sure they do.

14

Sen 11.15.20 at 11:21 pm

Thank you for this. I have a possibly naive and misguided question: how dependent is this situation on savers’ expectations that investment opportunities will eventually materialise? Could there be a disappearance of savers, qua “savers”, if those expectations dissolve and they give up on financial markets as a social institution to secure future benefits?

What I mean is this: as you explain, savers currently face a lack of investment opportunities both in markets and from governments, and at least in the case of markets, this lack has a fairly stable rationale in our current economic structure.

But I take it that this is all underpinned by expectations. Savers are continuing to look for investment opportunities despite them not being on offer, because they have an expectation (based on past history) that participation in financial markets is the best/main/only way to secure future rewards or stability. That is, this is a social institution that has worked in the past for savers.

But could this expectation dissolve if the situation stays like this for long enough? I am imagining a scenario where the economic structure stays the same and governments remain trapped by ideology. In this scenario, savers might eventually give up and turn to different social institutions.

One of my worries is that governments might therefore have less time to take advantage of this willingness to save (to fund green projects, social infrastructure, etc) than it might seem.

15

John Quiggin 11.16.20 at 6:53 am

Hidari @1 This is a big and important issue. I’m not fully on top of it yet, but I hope to write something soon.

Rapier @13, I talked about stock markets in an earlier post. Shouldn’t be hard to find.

Sen @14 I agree that expectations are crucial, and we can’t know for sure whether they will be fulfilled. And, unless governments act to increase investment, we face continuing problems.

16

Hidari 11.16.20 at 9:41 am

Incidentally, my first sentence should of course have read

‘ (I know that a situation where you don’t pay interests on loans doesn’t equate to ‘free money’…you DO have to pay it back, although in a world of inflation, even very low inflation, where interest rates are literally zero, you are essentially being paid to borrow),

17

Peter T 11.16.20 at 12:23 pm

Tentatively, it helps to distinguish between types of return, bearing in mind that interest is a return on money.

Private investment is looking for a direct return in money – you invest in plant or people, which make things/services for sale. Marx’s M-C-M.

Many public investments typically only yield a return indirectly – they raise overall productivity, and so allow greater tax revenues (highways or communications are good examples).

Some public investments prevent/mitigate losses. There is no money to be made or higher tax revenue flowing from flood prevention or habitat preservation (or defence). Spending on climate change or pandemic precautions is of this type. Much of the ‘investment’ we will need for the next few decades is of this type. Is the low interest rate a reflection of this – that money returns will be low or non-existent?

18

Blissex 11.16.20 at 7:42 pm

The usual focus on “the interest rate” from the discredited wicksellian notion that there is one that determines the “long-term balance between investment and savings”, as if the political economy worked in a “loanable funds of precious metals” fashion.

What matters rather more than”the” interest rate is how much exogenous credit and how much liquidity are offered to whom at which cost, and of those the most important is the amount of credit to whom.
Currently exogenous credit is gifted in whichever quantity at real negative rates for asset price speculation, and is scarce and expensive for investment in production, at least in the “western world”. So asset cost inflation is roaring, and wage inflation is negligible to negative.

JM Keynes advocated keeping the productive economy in a state of permanent semi-boom, the current credit policies of most “western world” governments are to keep it in a permanent state of semi-recession and to keep the unproductive economy in a permanent state of bubble. It is all very good for upward redistribution, but it may end in big problems…

19

Frank Wilhoit 11.16.20 at 8:59 pm

Hidari @ 1:

“…Surely 40 or 50 years ago, you had to pay for the smallest piece of paper or paper napkin, not get it for free as now….”

That word “surely” is a bit of a tell…! I was there. Nothing has changed. I have never paid for a napkin in my life (nor, for that final increment of clarity, been asked to). Actually, slightly fewer restaurants have napkin dispensers on the tables today than in 1970, but the difference is not large. Sometime in the 1980s (? it all blurs together) one heard about certain restaurants making a nominal charge for water. They were quickly shamed out of that.

But while that particular speculation may be off the mark, you do have an important larger point about long-term trends in margins and how businesses [over]react to those trends.

20

divelly 11.16.20 at 9:04 pm

Hidari@3
Napkins are free because The Evil Empire charges $5 for a cuppa!

21

Rapier 11.17.20 at 1:36 pm

In fiscal year 2020 the Fed monetized the equivalent of the entire $3.1TN deficit, plus. From mid-March and mid-June, the Fed’s portfolio of securities held outright grew by $3.9 trillion. Over the last few months it has been monetizing the equivalent* of almost 90% of Treasury borrowings on an ongoing month to month basis. Despite that 10yr Treasury Notes have been rising and are now brushing against 1% That is why the Fed is going to soon announce, probably before the December meeting that they are going to double QE.

The Feds Primary Dealers are sitting on record amounts of Treasury securities, imperfectly hedged, and financed by short term borrowing. If rates were to rise above 1% the dealers would literally be on the road to collapse. Which is why the Fed is going to increase its purchases of Treasury Notes from $80bn a month to probably $150bn a month. Well above the amount of Treasury borrowing. In other words monetizing the entire deficit.

Meanwhile and as always since Central Banks were invented the absolute cardinal rules will remain in place and be genuflected before. That is central banks must not be seen as monetizing a large portion of government borrowings. Go figure.

*The Fed buys Treasury securities and Mortgage backed securities. Buying MBS is not a direct subsidy of Treasury borrowing but the current $40bn a month is still $40bn of additional demand for debt assets so effects all rates including Treasury rates.

I realize discussing the mechanisms of how the monetary/credit system doesn’t matter. Why discuss mechanisms and systems when we have words like “ease” and “confidence” and “growth”? Sorry .

22

Eli Rabett 11.18.20 at 3:24 am

This is great news for anything that requires capital investment, e.g. renewable energy, where the heavy cost is up front and operation cheap. Nuclear and hydro too.

23

AnthonyB 11.18.20 at 5:13 pm

@MrMister

When a government sells bonds, that decreases the money supply, the opposite of “printing money.”

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