How much should we borrow?

Why the “natural” interest rate is zero

Modern monetary theorists consider monetary policy to be a poor tool for counter-stabilisation. It is indirect, blunt and relies on uncertain distributional behaviour. It works with a lag if at all and imposes penalties on regions and cohorts that may not be contributing to the price pressures (for example, when Sydney property prices were booming all of regional Australia which was not was forced to bear the higher interest rates). There is also no strong empirical research to tell us about the impact on debtors and creditors and their spending patterns. It is assumed implicitly that borrowers have higher consumption propensities than lenders but that hasn’t been definitively determined.

For a modern monetary theorist, fiscal policy is powerful because it is direct and can create or destroy net financial assets in the non-government sector with certainty. It also does not rely on any distributional assumptions being made.

It makes much better sense not to offer a support rate at all. In that situation, net public spending will drive the overnight interest rate to zero because the interbank competition cannot eliminate the system-wide surplus (all their transactions net to zero – no net financial assets are destroyed).

So in pursuit of the “natural” policy goal of full employment, fiscal policy will have the side effect of driving short-term interest rates to zero. It is in that sense that modern monetary theorists conclude that a zero rate is natural. This article by Warren Mosler and Mathew Forstater is useful in this regard.

If the central bank wants a positive short-term interest rate for whatever reason (we do advocate against that) – then it has to either offer a return on excess reserves or drain them via bond sales.

Our preferred position is a natural rate of zero and no bond sales. Then allow fiscal policy to make all the adjustments. It is much cleaner that way.

And all those bright sparks in the central bank could be redirected (retrained) to studying cancer cures or engage in something else that is useful.

source: http://bilbo.economicoutlook.net/blog/?p=4656

“ the budget deficit should fluctuate in such a way as the minimize the long run deadweight cost of taxation. ”

How does this all relate to unemployment? I see liberalish commentators like Matt Yglesias arguing that the government should have huge budget deficits just in order to boost employment back up as quickly as possible. Of course that is also smart politics. Periods of high unemployment seem to negatively impact the long term career prospects for many people, reducing “human capital”, and also to reduce marriages and the number of children born. So it seems that any analysis of the impact of budget deficits would need to look at how they impact unemployment, and then how unemployment impacts career prospects, marriage, and child bearing.

The reason we haven’t gotten inflation is obvious to me.

The biggest undiscussed story in the world is what is happening with population. In all the developed countries, family formation is plummeting, even as debts skyrocket. There is no way that these debts can be paid off with much smaller populations of savers.

A great blog post on the topic (not my own) is here:
https://econimica.blogspot.com/2021/03/the-narrative-of-inflation-amid.html

So why haven’t we gotten inflation? Simply put, developed countries have huge populations in the ages of, say 45-70, when earnings are still high but spending is much lower. Meanwhile, new family formation is low to very low and demand is therefore supressed.

Looking at the life cycle, children, young people and those establishing young families transitioning to homeownership are net consumers while people in the second half of their working life are net savers. But because of the inverted population pyramid across the G-20 there are more people in the saving stages of life than in the consuming stages of life, leading to a huge international bolus of savings, surprisingly low demand, and the answer to the question, “why is there so much demand for bonds and so little inflation?”

This situation is plainly very temporary. The much smaller cohorts following cannot possibly carry all this debt. And the current high-saving cohort must inevitably retire and draw on these savings. The dollar must crater, it would seem.

Let’s take South Korea as an example. They have for many years maintained a strong current account surplus. But their fertility rate in the most recent quarter was all the way down to 0.75 births/woman which is only around 1/3 of the replacement level. At this rate each cohort would be only 1/3 of the size of the previous cohort, and a generation of Korean grandchildren would be only 1/10 the size of a generation of grandparents. China, Japan and Germany, are all aging this way (and the US to a lesser extent) although not quite as sharply yet. Our bonds represent the savings of these countries, but as they age and dis-save, the capital flows are supposed to go the other way. Somehow Americans are supposed to turn our massive international deficits into surpluses as our aging lenders start needing their money back. At that point the dollar would have to decline dramatically it would seem because the US has its own demographic problems. We can’t even generate a positive balance of trade during these better times, before demographic decline sets in.

Immigration hasn’t helped a great deal because most immigrants into the developed world are very poor and not a major source of savings to buy bonds. In fact, most immigrants in the latest decades have increased, not decreased, the government’s obligations.

Is the current glut of savings ahead of depopulation across the developed world not the greatest temporal dislocation in economics history? In fact, it seems like the greatest problem in all categories in economics history.

And meanwhile policymakers imagine that the current surge of savings is some permanent new utopia to be happily enjoyed when it is literally a loan that we cannot hope to pay back.