Productivity bleg

Marcus Nunes directed me to a Project Syndicate post by Ernest Liu, Atif Mian, and Amir Sufi, with a nonsensical headline:

Could Ultra-Low Interest Rates Be Contractionary?

That’s not even a question.  I won’t blame the authors, as headlines are usually written by editors.  But this confused me:

The traditional view holds that when long-term rates fall, the net present value of future cash flows increases, making it more attractive for firms to invest in productivity-enhancing technologies. Low interest rates therefore have an expansionary effect on the economy through stronger productivity growth.

This is a basic EC101 error—reasoning from a price change.  Actually, productivity growth tends to be lower when interest rates fall.

Now some will argue that they obviously meant something different, that lower interest rates caused by a more expansionary monetary policy will tend to boost productivity.  OK, but the article is about recent events, and lower interest rates worldwide are certainly not being caused by a more expansionary monetary policy.  More importantly, I don’t ever recall a “traditional” model of the economy making that claim.  Indeed isn’t this the traditional view:

A view deeply entrenched in mainstream macroeconomics is that trend productivity growth is the outcome of technological and institutional factors and can be treated essentially as an exogenous force, unresponsive to business cycles or monetary policy actions. The workhorse macroeconomic models used by international organizations and central banks are built upon this notion.

So here’s my request.  Please direct me to the “traditional” models that claim low interest rates cause faster productivity growth.  I don’t doubt that heterodox models exist that make that claim, but I’m looking for traditional models that make that claim.  Where are they?

More broadly, the tendency of economists to equate low interest rates and easy money is becoming a major embarrassment for the profession.  We really are going back to the Stone Age.



14 Responses to “Productivity bleg”

  1. Gravatar of Judge Glock Judge Glock
    20. September 2019 at 09:52

    At least it’s a long-term embarrassment for the profession. I talked a bit on David Beckworth’s show about how an obsession with low long-term interest rates in the Great Depression caused the Fed to misjudge their efforts then. (Taking off of some of your work off course.)

    Friedman’s and others contributions on interest rates in the 1960s in this regard seem like an unfortunately brief light in the darkness.

  2. Gravatar of Christian List Christian List
    20. September 2019 at 10:26

    Maybe their paper clears things up (but I doubt it):

    “The focus of this paper is on understanding how the supply-side of the economy responds to a reduction in long-term interest rates driven by demand-side forces. The existing literature in growth either assumes no supply-side response to declining interest rates, or a positive response driven by an increased incentive to invest in the face of a higher discounted present value of future profits.”

  3. Gravatar of CF Prof CF Prof
    20. September 2019 at 10:29

    The “traditional” view expressed by the authors appears to be a partial equilibrium one. If interest rates exogenously fell (so the drop has nothing to do with general macroeconomic conditions), then every firm’s cost of capital would also fall, making investment more attractive. They want to argue against this view by saying that a more general equilibrium model, in which firms are in product market competition with each other, predicts exogenously lower rates decreases aggregate investment by increasing monopoly power for market leaders. The authors claim to make the interest rate endogenous in their model, but continue to discuss interest rate changes as an essentially exogenous event. In other words, the paper claims to be about the impact of interest rate changes on aggregate output, but fails to address the macroeconomic question of why the interest rate changes in the first place.

  4. Gravatar of ssumner ssumner
    20. September 2019 at 10:38

    Judge, I look forward to hearing your podcast.

    I’d add that back before 2008, mainstream economists like Mishkin and Bernanke agreed with Friedman.

    Christian, That’s certainly much better!

  5. Gravatar of ssumner ssumner
    20. September 2019 at 10:43

    CF, Good analysis. You said:

    “The “traditional” view expressed by the authors appears to be a partial equilibrium one. If interest rates exogenously fell (so the drop has nothing to do with general macroeconomic conditions), then every firm’s cost of capital would also fall, making investment more attractive.”

    I should point out that the partial equilibrium view implicitly assumes that interest rates change due to macroeconomic factors, outside the particular market being examined.

  6. Gravatar of ssumner ssumner
    20. September 2019 at 10:45

    Everyone, Just to be clear, I’m not criticizing their model. I haven’t even read their longer paper. I was surprised by their claim about the “traditional view”, and wondered whether that is in fact the traditional view.

  7. Gravatar of Al Al
    20. September 2019 at 11:18

    Don’t have time to look at the paper, but thinking back to grad school, isn’t this an implication of the Cass-Koopman’s interpretation of the Ramsey growth model? The higher the discount factor for future consumption, the higher the equilibrium interest rate and capital stock, which implies a higher marginal product for labor. So the missing step is that the source of the lower interest rate is caused by an exogenous change in preferences leading to higher savings. (Sort of the “global savings glut” story that’s been making the rounds for awhile.) This gets us back to general equilibrium.

  8. Gravatar of Benjamin Cole Benjamin Cole
    20. September 2019 at 16:48

    Everyday I read in the financial media and from economists that Japan has a hyper-accommodative monetary policy.

    Japan just posted 0.5% inflation year-over-year and wages are stagnant. On a more positive note, for the first time in 28 years land values are rising in Japan. By 0.4% in August year-over-year.

    Inside the Temple of Orthodox Macroeconomics there is hall devoted to the Totem of Higher Interest Rates. Many an acolyte can be heard chanting there.

  9. Gravatar of Benjamin Cole Benjamin Cole
    20. September 2019 at 21:00

    OT, but in the ballpark.

    Okay, the elephant in the room was just joined by his herd.

    This week, the Fed conducted QE operations, that is digitizing cash to buy Treasuries, of $275 billion. In four days! In the old days, the Fed did QE of $50 billion a month.

    Now, the Fed says it will continue at $75 billion a day (!) in bond-buying through Oct .10, if necessary.

    No one seems to know if the Fed will have to do this. But if they do what say they are willing to do, we will see another $900 billion of QE by Oct. 10.

    Some have noted the demand for cash in the inter-bank lending market has cooled off a bit. So maybe the Fed can handle the situation for only a total of, say, $500 billion in QE in one month.

    What does this mean? Nothing?

    And what if this situation recurs, say, annually? $500 billion in QE every year?

    We are turning to MMT, without a shot being fired, or even a florid proclamation from AOC-Sander.

    The banking system wants MMT, so we get it!

  10. Gravatar of ssumner ssumner
    20. September 2019 at 21:32

    Al, Sure, but the post sort of implies that the low rates are caused by easy money, not a higher saving preference.

    Ben, You said:

    “The banking system wants MMT”

    Are you off your meds again?

  11. Gravatar of Benjamin Cole Benjamin Cole
    21. September 2019 at 02:41

    Scott Sumner: No meds, I just have on my tinfoil hat.

    No MMT? What do you call it when the US national government borrows heavily, and the US central bank buys lots of Treasury bonds simultaneously?

    That bird is quacking, that bird likes to take to water, that bird makes a V when it flies in the sky with other birds.

    I am taking off my tinfoil hat in salute, and I am calling that bird a duck!

    I think Michael Woodford agrees.

  12. Gravatar of ssumner ssumner
    21. September 2019 at 07:57

    Ben, You said:

    No MMT? What do you call it when the US national government borrows heavily, and the US central bank buys lots of Treasury bonds simultaneously?”

    I call it an expansionary fiscal policy. I don’t think you have any idea what MMT is. It’s not a policy, it’s a theory.

  13. Gravatar of LK Beland LK Beland
    22. September 2019 at 10:27

    This model seems to do this, to a certain extent:

    “Capital Misallocation and Secular Stagnation”.
    by Caggese & Pérez-Orive

    “In the tangibles economy, capital allocation improves and there is an expansion of capital and output of high-productivity firms. High-productivity firms have a high leverage and the decline in the interest rate benefits them, both because it is easier to pay back debt (the net debtor channel) and because they can borrow more when they invest (the collateral value channel).”

  14. Gravatar of Doug M Doug M
    22. September 2019 at 16:01

    First when we say interest rates fall, which rates. Long-term and overnight are not the same thing.

    However, in my ec 1 class, it was presented as so.

    Firms have a set of projects which they are considering for investment. Each has an expected ROI. If the ROI exceeds the cost of capital, they will initiate one of these proctets. Falling rates is a lower cost of capital. So, we should see increasing investment when rates fall. Increased or improved pant and equipment will lead to productivity growth. But, we will not see that unlit the project is complete and the equipment is installed. That could be months ore even years down the line.

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