Last night I started planning the three posts I promised yesterday. I think I may have to scale back my ambitions – but at least I didn’t make a ‘cast-iron guarantee’.
So rather than covering the issues raised in three (what would be very long posts) I shall instead cover them in a few more shorter posts.
What I’m arguing is that Government can control long term (as well as short term) interest rates and that through this they can increase investment levels in the economy. This has the short term economic effect of making the economy more stable, the long term economic effect of higher growth and the ‘political/social’ effects of reducing both inequality and the power of financial capital.
On reflection I intend to proceed as follows (probably with the odd post on other issues to break the tedium for those not at all interested): starting to today with a couple of definitional issues on interest rate policy, I will then discuss Keynes’ liquidity preference theory, the mechanics of how interest rates can be controlled, the history of monetary reform and finally some policy implications for now.
What I’m advocating is a secular cheap money policy – i.e. not just using low rates to combat depression but having them as a permanent part of our economy.
The first thing we must do is distinguish between ‘easy money’ and ‘cheap money’.
One objection that I expect to be raised to my proposal is that we already have a ‘cheap money’ policy – that interest rates have been held too low for too long causing asset price bubbles, global imbalances and excessive consumer debt . This is incorrect – a misunderstanding driven by economists’ (in many cases) poor knowledge of economic history.
In the past year much of the West has had a cheaper money policy (ultra-low rates at the short term and QE on longer term rates) but the real yield (adjusted for CPI inflation) on UK ten year bonds is still 2.6%. That sounds low. But from 1870 until 1913 it averaged 2.4% and in the 1930s 2.7% (not much higher).
Greenspan spoke of the ‘conundrum’ of low long term real rates earlier in this decade. In reality the period of the 1980s until last year was the real conundrum. As an IMF paper of 2006 noted:
We show that current levels of real interest rates on long-term bonds in advanced economies are not low by historical standards and that it is the real long bond rates of the early 1980s through much of the 1990s that look anomalous.
In short, current levels of long-term real interest rates of around 2 percent among advanced countries appear low from the vantage point of the 1980s and 1990s, but not so low when compared with earlier epochs. In addition, periods when long-term real interest rates are below the economy’s growth rate—as they have been recently in some advanced economies (notably the United States)—are not exceptional. This was clearly the case in the last two decades of the classical gold standard, the interwar period as a whole, and the early postwar period through the 1960s.
I define ‘cheap money’ as a policy of low real long-term rates. By this definition the period from the mid 1970s until very recently can be considered a period of ‘dear money’. And policymakers globally are already discussing a return to this policy.
It is noticeable that long term periods of cheap money are associated with long term booms.
If ‘dear’/’cheap’ money can be defined by price (the rate) then ‘easy’/’tight’ money can be defined by availability & supply. Since financial liberalisation in the 1970s – money has certainly been ‘easy’. Credit availability increased and personal borrowing in particular soared.
The period from the mid 1970s until very recently then represents a time of ‘dear’ but ‘easy’ money. We are currently (with the policy response of low rates and QE but a broken banking system) in a period of ‘cheap’ but ‘tight’ money. The long term aim of policymakers appears to be a return to ‘dear’ but ‘easy’ money. This is misguided.