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I think what's really interesting is exploring the dynamics around lowering or raising the interest rate. Lowering it will tend to pull purchases from the futu

I think what's really interesting is exploring the dynamics around lowering or raising the interest rate. Lowering it will tend to pull purchases from the future to the present, everything else equal. But -- at least with housing -- all other things aren't equal; lowering the interest rate also drives up property prices. Once something is expensive enough that say, 95% of the population has to finance it, the purchase price is no longer really a consideration. Sure you might sign on a mortgage that ostensibly says you start out owing $300k or whatever, but in reality what you're signing on is an obligation to pay $2k/month for the next 30 years, or until you sell it, go broke and move out, etc. At 10% interest the $2k/mo doesn't have all that large of a price-artifact; it's about $200k. At 4% interest, the $2k/mo price-artifact is $375k. This is interesting and serves to illustrate that lowering the interest rate doesn't really "help" real-estate except to ensure that people aren't underwater in houses they paid too much for. In the non-financing world, a high interest rate means that you get a future-discount by saving your money and buying it later. And a low interest rate means that you get less of a future-discount by waiting to buy. When I say "a high interest rate" I'm talking about the real interest rate, interest minus inflation. The nominal interest rate doesn't matter save for some psychological effects. You can get that by having 10% interest and 4% inflation or 2% interest and 4% deflation, either way the real interest rate is 6%. But when the interest rate is 1% and inflation is 3% then the real interest rate is negative, -2% and you're a fool to save any money at all; everything else equal. This is how lowering the interest rate pulls future purchases into the present. Here's the kicker though: eventually there's less and less future purchases to pull from, and as a result the inflation has to get ever-more severe. As you start to approach spending all your money on debt service, you have less and less ability to take on new debt. And that means that the terms have to get substantially more favorable, and seemingly the only way to do that is to inflate enough to make the old debt less burdensome. Is that an underhanded form of theft? Probably, but it's the legal kind. The "hoarding" argument tends to fall apart if you consider all the things which a person HAS to buy; food, water, clothing, shelter, energy, transportation, etc. It's not as though you can not eat your vegetables because they're expensive for 20 years and then make up for that all at once. Can people make do with less? Sure. One person's "hoarding" is another person's ability to finance a house because the bank has enough savings to make the loan.

sosuke 12y ago
I think I follow, but if my $1 today is worth $1.10 in a year, deflation, at 0% interest, that is still 10% more value year to year for the bank making the loan. So $360 of money at the end of a 30 year loan, $1 per month, is worth $2,171.32 dollars in the end. That last $1 payment would be worth $209.39 dollars from the starting point. Isn't the loan still worth giving? My math is no doubt horribly off, but if each $1 is worth more that the end of the loan, deflation, or if I'm instead paying out more than $1 per month at the end of the loan, inflation, why is the deflated $1 worth less in a relative world view. Is the interest lost from inflation equal the value gained from deflation?
- msandford 12y ago
  Yeah it's a totally crazy concept. What you have to do is stop thinking about how many dollars a dollar will be worth, but think about the idea of purchasing power. So if the interest rate is 0% and there is 10% deflation, in a year my $1 will buy 10% more stuff. If the interest rate is 10% and 0% inflation, again in one year my $1 will buy 10% more stuff. If the interest rate is 0% and inflation is 10% then in 1 year my $1 will buy 10% less stuff. If the interest rate is -10% and inflation is 0% then in 1 year my $1 will buy 10% less stuff (provided that I don't take my cash out of the bank and hide it under my mattress/pillow/backyard/etc). That's why inflation is so appealing for people trying to prop up the economy; it's very, very difficult to enforce a negative interest rate because nobody's FORCING you to keep your money in the bank. It's just that it's usually smarter to do so than not. The problem with any kind of a negative real interest rate is that it punishes people for saving money. Saved money isn't just dollars in a bank account; it represents foregone consumption thus leaving extra, real resources available in the economy for people to invest into longer-term ventures. Those longer-term ventures typically involve capital equipment that will produce products which can be sold and thus both pay back the loan (with interest!) and produce a profit. This is how the economy grows. When people are punished for saving by having their purchasing power taken away, they tend to do it less. That leaves less resources for people to invest in new capital equipment, and that means we get less new products or prices which stay flat rather than fall slowly. I personally like the idea of having a world where things slowly get better but there are very passionate arguments that people make for the short-term about unemployment and the like. I believe that while well-intentioned they ultimately delay the re-alignment of the economy to the new realities of the world and thus everyone suffers more unnecessarily. But of course there's no way to prove how this stuff works either way so at this point it's more speculation than anything.

sosuke 12y ago

I think I follow, but if my $1 today is worth $1.10 in a year, deflation, at 0% interest, that is still 10% more value year to year for the bank making the loan. So $360 of money at the end of a 30 year loan, $1 per month, is worth $2,171.32 dollars in the end. That last $1 payment would be worth $209.39 dollars from the starting point. Isn't the loan still worth giving? My math is no doubt horribly off, but if each $1 is worth more that the end of the loan, deflation, or if I'm instead paying out more than $1 per month at the end of the loan, inflation, why is the deflated $1 worth less in a relative world view. Is the interest lost from inflation equal the value gained from deflation?

msandford 12y ago
Yeah it's a totally crazy concept. What you have to do is stop thinking about how many dollars a dollar will be worth, but think about the idea of purchasing power. So if the interest rate is 0% and there is 10% deflation, in a year my $1 will buy 10% more stuff. If the interest rate is 10% and 0% inflation, again in one year my $1 will buy 10% more stuff. If the interest rate is 0% and inflation is 10% then in 1 year my $1 will buy 10% less stuff. If the interest rate is -10% and inflation is 0% then in 1 year my $1 will buy 10% less stuff (provided that I don't take my cash out of the bank and hide it under my mattress/pillow/backyard/etc). That's why inflation is so appealing for people trying to prop up the economy; it's very, very difficult to enforce a negative interest rate because nobody's FORCING you to keep your money in the bank. It's just that it's usually smarter to do so than not. The problem with any kind of a negative real interest rate is that it punishes people for saving money. Saved money isn't just dollars in a bank account; it represents foregone consumption thus leaving extra, real resources available in the economy for people to invest into longer-term ventures. Those longer-term ventures typically involve capital equipment that will produce products which can be sold and thus both pay back the loan (with interest!) and produce a profit. This is how the economy grows. When people are punished for saving by having their purchasing power taken away, they tend to do it less. That leaves less resources for people to invest in new capital equipment, and that means we get less new products or prices which stay flat rather than fall slowly. I personally like the idea of having a world where things slowly get better but there are very passionate arguments that people make for the short-term about unemployment and the like. I believe that while well-intentioned they ultimately delay the re-alignment of the economy to the new realities of the world and thus everyone suffers more unnecessarily. But of course there's no way to prove how this stuff works either way so at this point it's more speculation than anything.