5 ms·

Can anyone explain to me why we don't have a policy of 'natural' or 'equilibrium' interest rate? As I studied finance in college in the 2010s I was aghast to re

by boppo1 4y ago

Can anyone explain to me why we don't have a policy of 'natural' or 'equilibrium' interest rate? As I studied finance in college in the 2010s I was aghast to realize that the US had basically turned into a centrally planned economy, and could not wrap my head around how any serious economist could advocate for the paradigm with a straight face. I'll never forget my freshman year investment analysis professor angrily and incoherently (to us hungover, careless freshmen) ranting about QE and going out for chain-smoking-breaks. It's so clear now.

dgellow 4y ago
> I'll never forget my freshman year investment analysis professor angrily and incoherently (to us hungover, careless freshmen) ranting about QE and going out for chain-smoking-breaks. It's so clear now. Could you enlighten us? What is so clear?
- boppo1 4y ago
  Asset inflation, erosion of the middle class, rise of unprofitable business getting lots of investment, etc.
hdhejenennd 4y ago
What would a "natural" interest rate mean to you? No open market operations, or what?
- boppo1 4y ago
  Yes, that. Not sure how the market for FF would work since that's not impacted by OMO, but I'm sure there'd be a way to just 'leave it to the market'.
hef19898 4y ago
What makes you think that the economy featuring the most un-chained capitalism is a centrally planned economy? I wasn't aware of any government dictated 5 year plans or similar thing anywhere in the western world.
- boppo1 4y ago
  The FOMC is a planning committee. Even if you keep your hands out of all the other parameters of industry, setting benchmark rates dictates what kinds of businesses succeed. It's like a string that all the other strings on the marionette connect to. You don't get granular control, but you're definitely exerting a huge amount of deliberate influence.
notahacker 4y ago
Because there's no such thing as a 'natural equilibrium' interest rate[1]. The base interest rate is an equilibrium, which regardless of monetary policy regime is influenced by something completely artificial (the quantity of base money in an economy) and lending activity. The Fed deciding to set the quantity of base money added to an economy 'no more ever' or 'x% per year' or 'in proportion to stocks of some shiny metal' or some other target leads to every bit as much of an artificial equilibrium interest rate, it's just that the vast majority of alternatives lead to more volatility and lower growth. [1]OK, there's Wicksell defining "natural" interest rate as one which leads to commodity price stability, but a slight modification of Wicksell's definition of price stability (to avoid the threat of destabilising deflation) has actually been the Fed's primary objective over recent decades...
- boppo1 4y ago
  I mean, if we didn't interfere with the buying/selling of treasuries, wouldn't that be equilibrium?
  - notahacker 4y ago
    It'd just be a considerably less stable equilibrium than the one we have now. It's not like treasuries and dollar reserves a central bank put into circulation before a certain date are natural things emerging out of a market demand and the ones after they put into circulation after a certain date are "interference". There is a market for credit and a dependency of that market on artificial things called dollars the Fed conjured from thin air regardless, the only question is whether the Fed's policy on artificially created dollars is to continue to attempt to supply them in quantities necessary to maintain a stable economy or not.
    - boppo1 4y ago
      The market for treasuries would exist exist without theed, since they're issued by the treasury. Why not set a limited quantity of dollars and have that be that, or a quantity that strictly grows at some pre-defined and predictable rate? I'm familiar with the argument that people would theoretically hoard deflationary currency, I'd counter that people will always spend to eat and purchase shelter. Calling shots like we are obviously isn't working and the only 'stability' seems to be a nominal one in asset prices. Everyone is otherwise bemoaning how broken the economy is. Great, we kept boomer pensions safe and quietly watched wage/salary earners' purchasing power erode. Seems like a false 'stability' to me.
michaelt 4y ago
One serious economic theory states there is a 'business cycle' [1], where the economy varies between doing well and doing badly every, say, 5-10 years. Keynesian economists [2] think the government should dampen these cycles by saving up a war chest when the economy is doing well, and spending when the economy is doing badly. After all, if there's a Great Depression and you build the Hoover Dam, you get a big discount on the construction because nobody else is building - and you get 10,000 jobs for people who would otherwise be idle. So the idea of targeting a given amount of growth, pressing the throttle on the economy when below that and the brakes when above it, is a well established notion. Of course, these days in practice election cycles don't match business cycles, and there ain't no way Party A is building up a war-chest so Party B can deliver tax cuts, or vice-versa. And if a sector of the economy - like house prices - is overheating, the government is as likely to cut taxes to help out buyers, as it is to raise taxes to reduce price growth and build up a war chest. [1] https://en.wikipedia.org/wiki/Business_cycle https://en.wikipedia.org/wiki/Business_cycle [2] https://en.wikipedia.org/wiki/Keynesian_economics https://en.wikipedia.org/wiki/Keynesian_economics
- boppo1 4y ago
  Well that makes a lot of sense for fiscal policy, but what about monetary policy? A professor explained it "lower rates make it easier for businesses to get loans, so they can create jobs!" This seems wholly and obviously short-sighted to me. Where does the theory address whether those jobs create anything worthwhile? Inflated valuation of suboptimal or unprofitable business? These are really elementary questions/conclusions to explore: Iirc Keynes said you could jumpstart an economy in the short term by paying people to dig ditches and fill them in[0] and watch a local economy pop up to support that 'industry'. What if doing so doesn't help the other primary activities and you just wind up with a ditch-digger economy? You're wasting resources on useless work. [0]The actual quote is about filling jars with money, burying them in a mine, filling it with garbage and paying people to dig them out. I'm no bitcoiner but I had a chuckle about the guy who hired people to recover his hard drive from a landfill.
  - michaelt 4y ago
    > A professor explained it "lower rates make it easier for businesses to get loans, so they can create jobs!" [...] Where does the theory address whether those jobs create anything worthwhile? Economics 101 books assume every business is a medium-sized family-owned manufacturing company. If you're a medium-sized family-owned manufacturing company, your growth might be constrained by access to capital - there might be several different investments in machines you could make, any of which would pay for itself within ~5 years, but you've only got the cash to get one machine. With more access to capital you can get a second machine, and hire the people to operate it - meaning more jobs and more profit. And of course you'd steer clear of unproductive investments, short-term-ism and empire-building - you're planning to pass this business on to your children and grandchildren. You need a sustainable 10-to-20-year outlook, reliable, well-trained employees and an order book full of satisfied, profitable repeat customers. On the other hand, if your business model is 1. Use cheap loans to provide subsidised taxi journeys, 2. ???? 3. Profit - the economic theory books don't really explain that.

by boppo1 4y ago

dgellow 4y ago

> I'll never forget my freshman year investment analysis professor angrily and incoherently (to us hungover, careless freshmen) ranting about QE and going out for chain-smoking-breaks. It's so clear now. Could you enlighten us? What is so clear?

boppo1 4y ago
Asset inflation, erosion of the middle class, rise of unprofitable business getting lots of investment, etc.

hdhejenennd 4y ago

What would a "natural" interest rate mean to you? No open market operations, or what?

boppo1 4y ago
Yes, that. Not sure how the market for FF would work since that's not impacted by OMO, but I'm sure there'd be a way to just 'leave it to the market'.

hef19898 4y ago

What makes you think that the economy featuring the most un-chained capitalism is a centrally planned economy? I wasn't aware of any government dictated 5 year plans or similar thing anywhere in the western world.

boppo1 4y ago
The FOMC is a planning committee. Even if you keep your hands out of all the other parameters of industry, setting benchmark rates dictates what kinds of businesses succeed. It's like a string that all the other strings on the marionette connect to. You don't get granular control, but you're definitely exerting a huge amount of deliberate influence.

notahacker 4y ago

Because there's no such thing as a 'natural equilibrium' interest rate[1]. The base interest rate is an equilibrium, which regardless of monetary policy regime is influenced by something completely artificial (the quantity of base money in an economy) and lending activity. The Fed deciding to set the quantity of base money added to an economy 'no more ever' or 'x% per year' or 'in proportion to stocks of some shiny metal' or some other target leads to every bit as much of an artificial equilibrium interest rate, it's just that the vast majority of alternatives lead to more volatility and lower growth. [1]OK, there's Wicksell defining "natural" interest rate as one which leads to commodity price stability, but a slight modification of Wicksell's definition of price stability (to avoid the threat of destabilising deflation) has actually been the Fed's primary objective over recent decades...

boppo1 4y ago
I mean, if we didn't interfere with the buying/selling of treasuries, wouldn't that be equilibrium?
- notahacker 4y ago
  It'd just be a considerably less stable equilibrium than the one we have now. It's not like treasuries and dollar reserves a central bank put into circulation before a certain date are natural things emerging out of a market demand and the ones after they put into circulation after a certain date are "interference". There is a market for credit and a dependency of that market on artificial things called dollars the Fed conjured from thin air regardless, the only question is whether the Fed's policy on artificially created dollars is to continue to attempt to supply them in quantities necessary to maintain a stable economy or not.
  - boppo1 4y ago
    The market for treasuries would exist exist without theed, since they're issued by the treasury. Why not set a limited quantity of dollars and have that be that, or a quantity that strictly grows at some pre-defined and predictable rate? I'm familiar with the argument that people would theoretically hoard deflationary currency, I'd counter that people will always spend to eat and purchase shelter. Calling shots like we are obviously isn't working and the only 'stability' seems to be a nominal one in asset prices. Everyone is otherwise bemoaning how broken the economy is. Great, we kept boomer pensions safe and quietly watched wage/salary earners' purchasing power erode. Seems like a false 'stability' to me.

michaelt 4y ago

One serious economic theory states there is a 'business cycle' [1], where the economy varies between doing well and doing badly every, say, 5-10 years. Keynesian economists [2] think the government should dampen these cycles by saving up a war chest when the economy is doing well, and spending when the economy is doing badly. After all, if there's a Great Depression and you build the Hoover Dam, you get a big discount on the construction because nobody else is building - and you get 10,000 jobs for people who would otherwise be idle. So the idea of targeting a given amount of growth, pressing the throttle on the economy when below that and the brakes when above it, is a well established notion. Of course, these days in practice election cycles don't match business cycles, and there ain't no way Party A is building up a war-chest so Party B can deliver tax cuts, or vice-versa. And if a sector of the economy - like house prices - is overheating, the government is as likely to cut taxes to help out buyers, as it is to raise taxes to reduce price growth and build up a war chest. [1] https://en.wikipedia.org/wiki/Business_cycle https://en.wikipedia.org/wiki/Business_cycle [2] https://en.wikipedia.org/wiki/Keynesian_economics https://en.wikipedia.org/wiki/Keynesian_economics

boppo1 4y ago
Well that makes a lot of sense for fiscal policy, but what about monetary policy? A professor explained it "lower rates make it easier for businesses to get loans, so they can create jobs!" This seems wholly and obviously short-sighted to me. Where does the theory address whether those jobs create anything worthwhile? Inflated valuation of suboptimal or unprofitable business? These are really elementary questions/conclusions to explore: Iirc Keynes said you could jumpstart an economy in the short term by paying people to dig ditches and fill them in[0] and watch a local economy pop up to support that 'industry'. What if doing so doesn't help the other primary activities and you just wind up with a ditch-digger economy? You're wasting resources on useless work. [0]The actual quote is about filling jars with money, burying them in a mine, filling it with garbage and paying people to dig them out. I'm no bitcoiner but I had a chuckle about the guy who hired people to recover his hard drive from a landfill.
- michaelt 4y ago
  > A professor explained it "lower rates make it easier for businesses to get loans, so they can create jobs!" [...] Where does the theory address whether those jobs create anything worthwhile? Economics 101 books assume every business is a medium-sized family-owned manufacturing company. If you're a medium-sized family-owned manufacturing company, your growth might be constrained by access to capital - there might be several different investments in machines you could make, any of which would pay for itself within ~5 years, but you've only got the cash to get one machine. With more access to capital you can get a second machine, and hire the people to operate it - meaning more jobs and more profit. And of course you'd steer clear of unproductive investments, short-term-ism and empire-building - you're planning to pass this business on to your children and grandchildren. You need a sustainable 10-to-20-year outlook, reliable, well-trained employees and an order book full of satisfied, profitable repeat customers. On the other hand, if your business model is 1. Use cheap loans to provide subsidised taxi journeys, 2. ???? 3. Profit - the economic theory books don't really explain that.