Eight claims about interest rates
By Scott Sumner
Robin Harding has a new FT article that makes 8 claims about interest rates:
First, there is an intimate link between long-run interest rates and long-run economic growth.
There is some link, but when we get to point #4 we’ll see a problem with this claim.
Second, monetary policy is broken. In 2008-09, the Fed cut rates by 5 percentage points and it was not enough. Today it has far less room to respond to a recession.
The recession of 2008-09 was caused by tight money that depressed NGDP. The fall in NGDP caused the big drop in interest rates. Monetary policy is still highly effective, if used properly.
Third, if monetary policy is broken, fiscal policy must step in.
Fiscal policy is ineffective, due to monetary offset.
Fourth, lower interest rates make debt more sustainable.
You can’t have it both ways. Point #1 says rates are low due to weak growth. If true, then the low rates do not make debt more sustainable.
Fifth, capital stock should rise relative to output.
That’s reasoning from a price change. It’s only true if the low rates are caused by an increased propensity to save. If the capital stock “should” rise relative to output, it likely will.
Sixth, any asset in fixed supply is now more valuable, because its future cash flows can be discounted at a lower rate.
Again, this is reasoning from a price change. Perhaps rates are falling because future expected cash flows are falling. That certainly seems plausible for Japan and Europe.
Seventh, demand for housing will rise.
Not completely implausible, assuming the lower rates are not caused by a drop in the productivity of housing. But again, it’s reasoning from a price change unless one accounts for the cause of the low interest rates. Declining rates in the US during 2006-09 were partly caused by the housing slump, and thus did not boost demand for housing.
The final point is excellent:
Eighth, low interest rates make it harder to save. In particular, they make it harder to save for a pension, and harder to live off whatever capital accumulates. . . .
It is possible that this bout of low interest rates will end. Perhaps the Fed is mistaken and it will have to raise rates sharply in the future. Perhaps a burst of technological progress will raise growth and boost demand for capital.
But no one can choose to make that happen: this is not some perverse plot by Fed chair Jay Powell and ECB president Mario Draghi to make life miserable for the world’s savers. The long-run real interest rate balances the desire to save and demand to invest. Central banks are its servants not its masters.
The trend towards lower real interest rates has lasted for decades and is as likely to continue as to reverse. With central banks moving to ease, it is time to stop waiting for rates to recover and face the world as we find it.