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Why 8? Doesn’t there need to be a premium for borrowing money? If i can borrow money at zero percent inflation adjusted rate, that is a great deal and still inf

by sfe22 4y ago

Why 8? Doesn’t there need to be a premium for borrowing money? If i can borrow money at zero percent inflation adjusted rate, that is a great deal and still inflationary. I would say 12 percent would be neutral on 10 percent inflation.

blagie 4y ago
No, there doesn't need to be a premium on borrowing money. Why would there need to be a premium? If I can invest in businesses with 0% return and make a profit, that's generally good for short-term economic growth, and bad for long-term economic efficiency. I'm not arguing for more or less interest, but I don't think there is a "natural." Interest rates have gone negative several times in several contexts, and the universe didn't explode in a numerical singularity. I am arguing for having reason beyond "we've always done it that way" or "it doesn't make sense."
- refurb 4y ago
  Of course there needs to be a premium to lend money. Why would I lend someone money to get the same amount back (in real terms)? You'd need at least some premium to account for risk of non-payment, changes in inflation, etc. There doesn't need to be a consistent premium to borrowing money. So if I borrow $1M for 30 years right now the interest rate doesn't have to be 10% because most people assume inflation will come down, so the average inflation over 3 years might be 3-4%, so an interest rate of 5-6% is probably enough of a premium.
  - roflyear 4y ago
    To safely park cash. Think government securities.
    - refurb 4y ago
      Ok, fair point on that one. Eliminate the default risk and you're willing to take 0% or even a negative real interest rate.
      - roflyear 4y ago
        Yeah. But without getting value through some mechanism like that (or, imagine if you're convinced that equities will be flat or return negative over the next few years) you're correct - you should make money from lending money.
    - blagie 4y ago
      This is correct. If you have $100B, what are your options? 1) Risky return-yielding instruments, like stocks and bonds 2) Non-liquid assets, like land 3) A Scrooge McDuck giant vault full of cash 4) ... and so on. In many cases, a negative interest account works better than any of the above. Sweden was the first to employ them in 2009, with an interest rate of -0.25%. The world didn't implode, as people predicted. If I deposit $100B overnight at -0.25%, I've lost just north of half a million dollars for that night. That's enough to push me to look for other places to stash my money (stimulating the economy), but not enough to break me (assuming I have $100B, which unfortunately, I don't). Critically, if the economy is collapsing, and you expect stocks to go down, removing other places to stash money can prop them up.
      - prottog 4y ago
        > That's enough to push me to look for other places to stash my money Yep, you take your $100B and invest it in the US capital markets. Does nothing for Sweden's economy other than make it comparatively less competitive.
        blagie 4y ago
        If you're willing to handle forex risks.... If I borrow $1M in USD to buy a 11M SEK property in Sweden, and the dollar goes up, I'm drowning underwater. If the dollar goes down, I'm sitting pretty.
      - roflyear 4y ago
        People also forget that banks are only FDIC insured up to a certain amount, generally. So if you have like $1b, though unlikely, there are many reasons to not keep it in cash.
        blagie 4y ago
        People also forget that the negative interest rates are with central banks. They're not FDIC-insured because if they go under, that means the FDIC (together with the rest of the country) is gone.
- FormerBandmate 4y ago
  When interest rates are negative it's inherently inflationary. It won't destroy the universe but it encourages people and businesses to borrow to get additional resources (the deteriorating economic conditions right now make that a very bad idea, but in general this is true)
  - imtringued 4y ago
    >When interest rates are negative it's inherently inflationary. Is this supposed to be some kind of joke? When you have 3% deflation then a -3% negative rate just sets real returns back to 0% like one would expect in a functioning market. Also, a negative interest rate on cash allows the abolishment of inflation as central banks no longer need to target a positive inflation rate and can instead do price level targeting which is the complete destruction of the concept of inflation itself. Lower interest payments mean most of the payments go towards the principal which means the money supply shrinks given a sufficient debt brake on government spending. Negative rates allow 100% reserve requirements to function and mitigate almost all the problems with the loanable funds model which means the central bank doesn't have to control the interest rate anymore. If anything it is the opposite, if interest rates exceed returns in the real economy, the government has to borrow and spend to stimulate the economy until there is enough inflation to pay the interest rates expected of it.
mjburgess 4y ago
I was being conservative to give the author some room to make the argument. If rates are 8%, I can see this article at least being justified in its concern.
fennecfoxen 4y ago
We've had many years of 0% rates and 2%ish inflation. A return to that status quo ante isn't exactly crushingly tight monetary policy. But perhaps inflation will fall before we hit 8%.
- roflyear 4y ago
  Inflation is 8% right now, not 10%. So 6% seems to be a good "target" - but many economists in the US are thinking that inflation will not stay at 8% (that is the hope...) so they are aiming for a rate that reflects a 5.5-6.5% inflation rate over 2023 - which is from anywhere from 3.75% (I think at this point this is too low) to 4.75% (higher than expected). This makes a lot of sense to me and I think we'll see around a 4.5%-4.75% target rate by the end of 2023.
  - UncleMeat 4y ago
    Inflation was 8% averaged over the past year. Right now, the calculation is much more complicated and we observed nearly net zero price change of the basket over the past two months.
    - roflyear 4y ago
      Correct.
roflyear 4y ago
The idea is that you are TRYING to drive inflation down. You can borrow at 8%, and that's great when inflation is at like 10-12%, but once inflation goes down (the goal of high rates) it's bad.
koboll 4y ago
You are conflating backward-looking inflation (money has gotten 10 percent less valuable over the past year) with forward-looking inflation (we should lend at 12 percent interest because we expect money to get 10 percent less valuable over the next year). The former doesn't guarantee the latter; the latter is unlikely and gets unlikelier the more interest rates ratchet upward. That's why they are incremented - at a certain point inflation will inevitably reverse, and that point is likely below 12%, so going to 12% would unnecessarily knife the economy.

by sfe22 4y ago

blagie 4y ago

No, there doesn't need to be a premium on borrowing money. Why would there need to be a premium? If I can invest in businesses with 0% return and make a profit, that's generally good for short-term economic growth, and bad for long-term economic efficiency. I'm not arguing for more or less interest, but I don't think there is a "natural." Interest rates have gone negative several times in several contexts, and the universe didn't explode in a numerical singularity. I am arguing for having reason beyond "we've always done it that way" or "it doesn't make sense."

refurb 4y ago
Of course there needs to be a premium to lend money. Why would I lend someone money to get the same amount back (in real terms)? You'd need at least some premium to account for risk of non-payment, changes in inflation, etc. There doesn't need to be a consistent premium to borrowing money. So if I borrow $1M for 30 years right now the interest rate doesn't have to be 10% because most people assume inflation will come down, so the average inflation over 3 years might be 3-4%, so an interest rate of 5-6% is probably enough of a premium.
- roflyear 4y ago
  To safely park cash. Think government securities.
  - refurb 4y ago
    Ok, fair point on that one. Eliminate the default risk and you're willing to take 0% or even a negative real interest rate.
    - roflyear 4y ago
      Yeah. But without getting value through some mechanism like that (or, imagine if you're convinced that equities will be flat or return negative over the next few years) you're correct - you should make money from lending money.
  - blagie 4y ago
    This is correct. If you have $100B, what are your options? 1) Risky return-yielding instruments, like stocks and bonds 2) Non-liquid assets, like land 3) A Scrooge McDuck giant vault full of cash 4) ... and so on. In many cases, a negative interest account works better than any of the above. Sweden was the first to employ them in 2009, with an interest rate of -0.25%. The world didn't implode, as people predicted. If I deposit $100B overnight at -0.25%, I've lost just north of half a million dollars for that night. That's enough to push me to look for other places to stash my money (stimulating the economy), but not enough to break me (assuming I have $100B, which unfortunately, I don't). Critically, if the economy is collapsing, and you expect stocks to go down, removing other places to stash money can prop them up.
    - prottog 4y ago
      > That's enough to push me to look for other places to stash my money Yep, you take your $100B and invest it in the US capital markets. Does nothing for Sweden's economy other than make it comparatively less competitive.
      - blagie 4y ago
        If you're willing to handle forex risks.... If I borrow $1M in USD to buy a 11M SEK property in Sweden, and the dollar goes up, I'm drowning underwater. If the dollar goes down, I'm sitting pretty.
    - roflyear 4y ago
      People also forget that banks are only FDIC insured up to a certain amount, generally. So if you have like $1b, though unlikely, there are many reasons to not keep it in cash.
      - blagie 4y ago
        People also forget that the negative interest rates are with central banks. They're not FDIC-insured because if they go under, that means the FDIC (together with the rest of the country) is gone.
FormerBandmate 4y ago
When interest rates are negative it's inherently inflationary. It won't destroy the universe but it encourages people and businesses to borrow to get additional resources (the deteriorating economic conditions right now make that a very bad idea, but in general this is true)
- imtringued 4y ago
  >When interest rates are negative it's inherently inflationary. Is this supposed to be some kind of joke? When you have 3% deflation then a -3% negative rate just sets real returns back to 0% like one would expect in a functioning market. Also, a negative interest rate on cash allows the abolishment of inflation as central banks no longer need to target a positive inflation rate and can instead do price level targeting which is the complete destruction of the concept of inflation itself. Lower interest payments mean most of the payments go towards the principal which means the money supply shrinks given a sufficient debt brake on government spending. Negative rates allow 100% reserve requirements to function and mitigate almost all the problems with the loanable funds model which means the central bank doesn't have to control the interest rate anymore. If anything it is the opposite, if interest rates exceed returns in the real economy, the government has to borrow and spend to stimulate the economy until there is enough inflation to pay the interest rates expected of it.

mjburgess 4y ago

I was being conservative to give the author some room to make the argument. If rates are 8%, I can see this article at least being justified in its concern.

fennecfoxen 4y ago

We've had many years of 0% rates and 2%ish inflation. A return to that status quo ante isn't exactly crushingly tight monetary policy. But perhaps inflation will fall before we hit 8%.

roflyear 4y ago
Inflation is 8% right now, not 10%. So 6% seems to be a good "target" - but many economists in the US are thinking that inflation will not stay at 8% (that is the hope...) so they are aiming for a rate that reflects a 5.5-6.5% inflation rate over 2023 - which is from anywhere from 3.75% (I think at this point this is too low) to 4.75% (higher than expected). This makes a lot of sense to me and I think we'll see around a 4.5%-4.75% target rate by the end of 2023.
- UncleMeat 4y ago
  Inflation was 8% averaged over the past year. Right now, the calculation is much more complicated and we observed nearly net zero price change of the basket over the past two months.
  - roflyear 4y ago
    Correct.

roflyear 4y ago

The idea is that you are TRYING to drive inflation down. You can borrow at 8%, and that's great when inflation is at like 10-12%, but once inflation goes down (the goal of high rates) it's bad.

koboll 4y ago

You are conflating backward-looking inflation (money has gotten 10 percent less valuable over the past year) with forward-looking inflation (we should lend at 12 percent interest because we expect money to get 10 percent less valuable over the next year). The former doesn't guarantee the latter; the latter is unlikely and gets unlikelier the more interest rates ratchet upward. That's why they are incremented - at a certain point inflation will inevitably reverse, and that point is likely below 12%, so going to 12% would unnecessarily knife the economy.