Why Are Interest Rates So Low?

Ben Bernanke's first blog after leaving his job as the Chairman of the Federal Reserve, is a response to those who criticized the Fed for keeping interest rates too low.  He presents a good description of the determinants of interest rates and what the Fed does to influence those rates.  The Fed attempts to bring interest rates as close as it can to the equilibrium interest rate consistent with full employment and its inflation target.  The market plays a dominant role in this process.  When the expected rate of return on investment is high, the demand for investment loans will be high, and that will cause interest rates to rise.  The opposite will happen when the expected return on capital investment is low.  Interest rates are low primarily because the demand for investment funds in global economy is low.  Fiscal policy also plays a role in the process.  When governments borrow to fund deficits it absorbs more of the supply of savings which tends to increase interest rates.  The Fed, and other central banks, can affect the supply of money and short term interest rates through monetary policy but its actions are limited by the expectations that business has on the expected return on capital.

The Fed struggles to determine what the equilibrium rate is at any point in the business cycle.  That is the subject of much of the debate among members of the FOMC which recommends monetary policy actions.  If it too aggressive it can accelerate price inflation which drives interest rates higher.  If it is not aggressive enough, it will not satisfy its full employment of resources goal.  The primary reason for low global interest rates is that the expected return on capital investments is low.

Indiana's Religious Freedom Law And GOP Politics

Indiana passed a religious freedom law that has nothing to do with religious freedom.  Everyone in Indiana, and elsewhere, is free to practice whichever religion they prefer.  The law enables businesses to refuse services to individuals whose sexual practices violate their religious beliefs by protecting them from lawsuits.  Mike Spence, the Governor of Indiana, defended the law on national TV by claiming that it "empowers people".  Perhaps the real intent of the law is to empower the religious far right to vote for Republicans.  Nineteen other states have so called religious freedom laws.  Republican politicians are not concerned about religious freedom.  These laws are intended to strengthen their hold over "values voters" who have become the base of their Party.  They also provide another example of how the Republican Party has bastardized the concept of freedom.  This law provides legal freedom to one group so that it can take away the freedom of others to purchase products and services.  Jeb Bush, who has become the leading candidate for the GOP nomination in 2016, certainly understands the politics of the GOP base.  He has defended the Indiana law.  David Brooks also understands the values wedge that has been used by his party in election campaigns.  He attempts to make the religious freedom law credible by separating it from GOP politics.  He suggests that we should be tolerant of "minorities" who have strong values.  He means that we should be tolerant of the GOP's exploitation of the values held by a substantial portion of its base.  His job is to make GOP policies more tolerable to the better educated audience who reads his op-eds.

Seven Excellent Panel Discussions About Economics And Society

The New York Review Of Books has been one of the premier intellectual publications in the US for a long time.  It recently invited a stellar group of economists, social scientists and other intelligent observers of of our economic world to discuss the economics profession, its relationship to other academic professions and to society.  I think that each of these discussions are provocative and informative.  Many of us have been campaigning to have the video's released.  Thankfully, the NYRB has provided a public service by making them available at no cost to the general public.

Keynes On The Euthanasia Of The Rentier

Few of Keynes' critics have read his General Theory but some his critics have read Keynes very carefully and they have rejected his theory because it is incompatible with their political economy.  The General Theory is not easy read but Brad DeLong has posted some its most powerful arguments.  For those who have not read or understood Keynes, his posts may help you to better understand his political economy.  You will also understand why there is so much opposition to his political economy.

The General Theory was written in troubled times.  The world economy was depressed and many wondered whether there were superior alternatives to capitalism.  The General Theory made a case for a more enlightened capitalism that could provide for full employment, and maintain some of the positive features of capitalism that were superior to totalitarian economic systems.  Keynes saw functionless investors, or the rentier class, as an obstacle to a full employment economy.  Moreover, the maldistribution of wealth and income, that characterized the interests of the rentier class, was seen as an impediment to the growth of capital.  Keynes argued that a more progressive tax system would facilitate economic growth by redistributing income from those who saved much of their income to those who spent most of their income.  He believed that progressive taxation was a better alternative than revolution.  In other words, euthanasia was better than the warfare against the rentier class.

Keynes was also familiar with the arguments against progressive taxation.  Clearly, it would inspire tax evasion schemes, but it also might diminish the motivation for risk taking, and it might reduce the level of savings that were consistent with a full employment level of investment.  We should be familiar with these criticisms because they are still with us today.  Ronald Reagan made the same arguments in defense of his tax policies which rolled back the progressive tax policies that were legislated during the New Deal.  Reagan claimed that we needed a higher level of savings to stimulate investment, and that progressive taxes were a disincentive to risk taking and hard work.  In other words, a properly functioning capitalist system is dependent upon a high level of savings that could only be obtained from the rentier class.  Keynes believed that retained earnings provided enough capital to maintain business investment.  That is pretty clear in our current economy.  Corporations are only investing a small portion of their retained earnings.  They are using the majority of their retained earnings to provide dividends to shareholders, and to repurchase their own stock.  Keynes also believed that we needed an incentive system to reward hard work and risk taking.  He felt, however, that the system would operate just fine with a less substantial reward system.  Keynes could not even imagine the reward system available to corporate executives in our current era. 

Keynes also believed that the rentier class preferred high interest rates on their savings as well as high dividends.  Of course, high interest rates encourage savings, and they retard investment.  He believed that recessions occur when the pool of savings are greater than the level of business investment. He favored lower interest rates to encourage investment and to reduce the incentive to save.  Implicit in his analysis is the idea that there is an interest rate that is consistent with a full employment economy.  Ordinarily, monetary policy can be used to maintain a full employment economy.  The exception, of course, is when interest rates are close to zero and cannot be reduced far enough to stimulate investment and consumption.  Under those conditions, fiscal policy has more leverage than monetary policy.



  

Keynes On The Trade Cycle

Brad DeLong provides us with a description of the trade cycle (or business cycle) that is provided in Chapter 22 of the General Theory.  He then condenses it into a small number of bullet points.  Its pretty clear that the level of business investment, which is dependent upon the expected return on investment, is the critical factor in his theory.  Interest rates, and the relative scarcity of capital, play a role in the business cycle but they are less important than the expected return on new capital.  Downturns in the business cycle are steeper than recoveries because business pessimism and business optimism have different cycles.  Keynes, of course, was concerned with problem of overcoming pessimism and restoring optimism about the return on new capital.   The Great Depression was a case in point.  Business pessimism became self reinforcing during the Depression and Keynes looked to government investment as a means to reverse the business cycle.

When I look at the US economy today it seems different to me than it might have been in the 1930's.  We have deindustrialized and have become a services economy.  Healthcare services represent 17% of GDP and educational services are also major component of GDP.  Most of our households include two wage earners.  That has stimulated demand for daycare services and other services that satisfy the needs of two wage earner families. Financial services are also a larger part of the economy.  I could go on but my point is that the services industries are not as capital intensive as the industries that they have replaced.  Business investment, and the US business cycle, used to be heavily dependent upon the automobile sales cycle.  When Detroit had a good year the economy had a good year.  That is less true today.  A good share of the parts and finished products are produced elsewhere.  Buick sells more cars in China than it does in the US but the capital investment required to service that market does not occur in the US.  It makes sense for Buick to invest in China because the automobile market in China is now larger than the US market.  Capital investment will usually flow in the direction of the market.  The market for tradable products has become global and so has capital investment.

The real estate market is a capital intensive market and the investment required to satisfy the demand for real estate is local.  It is also an interest rate sensitive market since most of the development is financed with mortgages.  If we look at the business cycle in the US it is highly correlated with the availability and cost of mortgage finance.  The Fed has been able to use interest rates to expand and contract the huge real estate market and the US economy which is heavily dependent upon real estate investment.  It also eased regulations so that mortgage securitization enabled more credit to flow into the real estate market and expand access to mortgage finance by less credit worthy consumers.  To a large extent, capital investment in the US and the business cycle has been influenced by real estate investment and by monetary policy.  It is not surprising that the collapse of the real estate market, along with the debt hangover, has played such a huge role in the US business cycle. 

Given the changes in the US economy, and the globalization of capital investment, the US business cycle is more complex than it might have been when the economy was more capital intensive and most on the capital investment was domestic.  It may have become more dependent upon the flow of business activity that is triggered by new business ventures.

GOP Plan For Reducing Inequality Is A Plan For Increasing Inequality

Many Americans have become concerned about rising inequality.  Therefore, it makes sense for politicians to claim that have a plan for reducing inequality.  Even Republicans have jumped on this bandwagon.  Most Americans do not read the details of their proposals but those who do study their plans for reducing inequality have concluded that they will actually increase inequality.  This short article by John Cassidy points out a few of the ways in which GOP budget proposals will actually increase inequality.  We can't expect a leopard to change its spots.

Paul Ryan's plan to end the estate tax is one of the more egregious proposals made by the leopards who refuse to change their spots.  Ryan argues that the estate tax hurts small business people and farmers.  He gets away with this because most Americans don't know that the first $5.4 million of taxable assets for married couples is excluded from the estate tax.  Ryan's plan only benefits the wealthiest households in America.  Of course, Ryan knows about the $5.4 million exclusion, and so do most households that benefit from the exclusion.  Ryan gets away with his charade only because most Americans are not aware of the exclusion.   They also don't know that stocks, which have appreciated in value, can be passed on to heirs tax free.  That is, they do not have to pay a tax on the capital gain.  They inherit the stocks at their current market value and only have to pay a future tax on the gains over that value when they are sold.

Many Americans, including most Republicans, believe that social mobility and access to higher education are correlated.  Access to higher education, however, is also correlated with the cost of higher education.  That is why the Pell Grant program, which provides subsidies to low income Americans, was passed into law.  The Republican budget proposal reduces the subsidy from the Pell Grant program.  This is consistent with the behavior of Republican governors who have been cutting back state contributions to their state university systems.  That passes on more of the cost for higher education to students and their families.  That is one of the reasons why student debt in America exceeds the debt owed on credit cards or auto loans.  Mortgage debt is the only category of debt that exceeds the debt on student loans. 

It is difficult to make substantial changes in the ways that market incomes are determined.  Market income inequality has been growing in most western economies.  The major difference between the US and other western nations is that spending on social welfare programs in the US is much lower than it is in other rich countries.  Consequently, net income inequality, which reflects the contributions of social welfare programs, is substantially higher in the US than it is in other rich nations.  Consequently, one would expect that the Republican Party, given its new concern about income inequality, would want to bring spending on social welfare programs in the US closer to those in other rich nations.  The Republican Party has not changed its spots.  Over two thirds of the spending cuts in their budget proposal are realized by cuts in social welfare programs.

Rich nations are very different from poor nations.  Income inequality is typically much lower in rich nations because their citizens are better educated and their governments are less corrupted than those in most poor nations.  One could make a similar comparison between states in the US.  The low income states in the US have higher income inequality,  weaker educational systems, and more corrupt state governments.  They are also the states that are dominated by the Republican Party.  There is a reason why the leopard does not change its spots, and why the chances that the US moves closer to the ways in which first world nations function is a growing concern to the rest of the nation and even to our partners in other rich countries.

Economic Impact Of Strong US Dollar

Currency volatility has been one of the more significant factors in the global economic outlook.  This article from Fidelity describes the impact of the strengthening US dollar for the global economy and investors.