Never reason from a price change: example #331

The NYT had a story back in September with the following headline:

As Low Rates Depress Savers, Governments Reap Benefits

Before considering the impact on government finances, we need to first figure out what is causing the low rates.  Is it easy money or tight money?  To do that we look at NGDP growth, which has been very low since mid-2008.  This means the low rates are caused by tight money.  Unfortunately for the US government, as well as the governments of most European countries, this slow NGDP growth policy actually hurts government finances by raising spending and reducing tax revenues.  So although they pay less interest, the deficits get larger.  In contrast, the debt to GDP ratio fell slightly in the 1960s and 1970s, despite high interest rates.  Fast NGDP growth helps borrowers reduce their debt burden.

So if savers are hurt by tight money, and government borrowers are hurt by tight money, who’s helped?  Almost nobody.  There’s a deadweight loss when RGDP falls.  It’s like filling a ship with 1000 brand new cars, and sinking it in the middle of the Atlantic.  That’s what “deadweight loss” means.  A few T-bond holders are helped, but they typically also hold other assets, which fall in value.

PS.  I’m way behind in reading comments, but I’ll get to them.



13 Responses to “Never reason from a price change: example #331”

  1. Gravatar of RPLong RPLong
    9. November 2012 at 08:17

    How exactly is this post NOT reasoning from a price change? I must really not get it.

  2. Gravatar of Matt Waters Matt Waters
    9. November 2012 at 08:23

    Some extremely conservative savers can be helped by ruinous deflation, including T-bill holders, AAA corporate bond holders and those expecting pensions backed by the government. Their future nominal payments are just about constant.

    Those who happen to be holding cash when the deflation starts are also helped, but nearly all cash was held for required banking reserves.

    It can be hard to square with many people that we should be against policies that would help ultra-conservative savers. But people who bought and sold Treasuries in 2006 or those who provided and received pensions had inflation expectations of 2-3% and markets agreed on appropriate real interest rates. An unexpected deflation or inflation changed that agreement after the fact and gave government lenders more money than government borrowers agreed to give.

  3. Gravatar of Major_Freedom Major_Freedom
    9. November 2012 at 08:49


    To do that we look at NGDP growth, which has been very low since mid-2008. This means the low rates are caused by tight money.

    Incorrect. Interest rates have been on a downward trend since 1980, regardless of NGDP.

    For example, they were on a downward trend during the 1990s even though NGDP growth was roughly stable at 5%.

    Never reason from a spending change.

    You are missing the long term bull market in bonds. NGDP growth has been 4% since 2010. Why are rates CONTINUING TO FALL?

    NGDP is not the explanation for interest rates. Never reason from a spending change.

  4. Gravatar of Jason Jason
    9. November 2012 at 08:57

    Great point by Major_Freedom, the natural rate of interest looks to be changing a lot over time. There have to be a number of reasons for this depending on what approach you take to understanding what an interest rate is, whether its the finance approach of impatience, growth and uncertainty or whatever the Macro people do with marginal products. Does a change in the equilibrium natural rate of interest affect the optimal fiscal policy and optimal debt to GDP ratios? I’m pretty sure it would blow any sort of long-term Taylor rule analysis out of the water, one of many reasons.

  5. Gravatar of Laurent Laurent
    9. November 2012 at 09:04

    Is it sensible to interpret negative real interest rates as a market signal to governments? It could mean that the private sector cannot access or use this “free” money through conventional financial markets.

    The government has many means to facilitate these processes. Some of them more disruptive than others. Some forms of tax holidays could be efficient. Combined with the Fed’s open market operations, costs to future taxpayers can be small.

    Or am I getting this all wrong?

  6. Gravatar of ssumner ssumner
    9. November 2012 at 09:04

    RPLong, I’m reasoning from an NGDP change.

    Jason, Yup, the Taylor Rule should be dumped.

  7. Gravatar of Doug M Doug M
    9. November 2012 at 09:24

    As a saver, whether a falling interest rate is good or bad has everything to do with the duration of my assets.

    In the ’90s, I was trading US government bonds and Government guaranteed MBS (Ginnie Maes). Falling rates were unambiguously good for me. They made the prices of the bonds on my book rise and increased my P+L. Then I heard a conversation between a pair of retirees. They were incredibly fearful that the Fed would cut rates again, the yields of their CDs would fall, and they wouldn’t have the income on which they depended. Who the hell put these ladies’ savings into CD’s! They quite clearly held a portfolio that was not suited for their needs. They needed duration. They needed to be further out on the curve. They should be holding a combination of intermediate and long-term bonds.

    So, what is the ideal Fed policy for saver? I will do best when the Fed is in transition from a tight policy to an easy policy. The longer that they stay in easy-money mode, the worse I will do. If the Fed is stuck in an overly tight policy, I won’t do very well there either.

    I am not sure the debtor has the opposite risk profile of the saver. The debtor needs top line growth so that debts will fall as a proportion of revenues. But, high inflation hurts the debtor, too, as many of those debts will need to be refinanced.

    Both savers and debtors do best when inflation is low and stable.

  8. Gravatar of Matt Waters Matt Waters
    9. November 2012 at 09:24

    “Is it sensible to interpret negative real interest rates as a market signal to governments?”

    Real rates were negative for decades after World War II.

    I look at real rates this way. At any point, the central bank controls short-term interest rates. If they want to keep NGDP or inflation on a constant track, then at every point the market will determine the appropriate rate for the central bank. If the rate is higher than that, NGDP/inflation will be too low. If the rate is lower than that, NGDP/inflation will be too high.

    If that appropriate interest rate means a negative real rate, then it means people want to save so much that they will lose real wealth by not spending now. That’s not a government or central bank decision. That’s a decision by market preferences.

    In retrospect, the high real rates in the 80’s and 90’s were perhaps an outgrowth of capital misallocations during those decades. The market real rate is determined by not only demand but also supply. The supply curve shifts outward if markets believe there’s more positive-NPV investments than there actually are. Therefore, to keep inflation from going too high, central banks must make interest rates higher than if supply was limited to true positive-NPV investments.

  9. Gravatar of Floccina Floccina
    9. November 2012 at 10:50

    Scott, how about a few posts about the “fiscal cliff”. Wall Street is screaming about it, saying going off it will cause a big drop in RGDP but would the fed be able to counteract any effects? Since to spend is to tax is it not the best possible outcome?

  10. Gravatar of ssumner ssumner
    9. November 2012 at 11:05

    Floccina, I don’t expect the cliff to happen, but if it did the Fed would not fully offset the effects. Indeed it might not even fully offset the demand side effects in the short run, and then there are the supply-side effects.

    We need to reduce the budget deficit. If Wall Street is freaking out about it, then why doesn’t Wall Street start screaming for easier money? Actually the market is screaming for easier money, but I mean the commentators on Wall Street.

  11. Gravatar of Steve Steve
    9. November 2012 at 11:31

    November 8, 2012, 8:00 p.m. ET
    .Fed’s Bullard: Current Monetary Policy May Be Easier Than Thought

    –Says current Fed policy may be equivalent to -5% funds rate

    –Taylor Rule suggests funds rate should be at -2%, Bullard adds

    –Fed policy was too tight in 2009

    By Michael S. Derby
    ST. LOUIS–New thinking on monetary policy suggests the Federal Reserve’s current stance may be even more aggressive than many now understand, a U.S. central bank official said Thursday.

    Recent academic work suggests the policies now being pursued by the Fed “may currently be easier than the recommendations” suggested by traditional rules of thumb like the Taylor rule, Federal Reserve Bank of St. Louis President James Bullard said.

    Relying on the work of Leo Krippner of the central bank of New Zealand, Mr. Bullard said this new thinking suggests the policies now being pursued by the Fed leave the funds rate as equivalent to a negative-5% rate.

    “This value is considerably more negative than values recommended by common monetary policy rules,” Mr. Bullard said. This so called “shadow rate,” the official said, is “currently more than 300 basis points lower than the rate recommended by the Taylor rule.”

  12. Gravatar of Saturos Saturos
    10. November 2012 at 20:47

    It’s because of statements like this by Bullard (and the market anticipation of them) that monetary policy is in fact not as easy as he thinks. QE3 wasn’t really that kind of a commitment.

  13. Gravatar of Major_Freedom Major_Freedom
    18. November 2012 at 00:14


    Floccina, I don’t expect the cliff to happen, but if it did the Fed would not fully offset the effects.

    That’s because if a recession hits, we have to blame not enough inflation. Inflation is a panacea.

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