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Interfluidity: The negative unnatural rate of interest (November 8th, 2011)
I think this aberrationist view is quite wrong. I don't think you can make sense of the last decade without understanding that the so-called real interest rate has been trying to fall through zero for years. Only tireless innovation by the men and women of Wall Street prevented negative rates long before the traumas of 2008. A deep cause of the financial crisis was a simple expectation: That lenders ought to earn a "decent" real, risk-free yield even while a variety of trends -- skyrocketing incomes for the 0.1%, the professionalization of investing, leverage-induced risk aversion, China -- were creating Ben Bernanke's famous savings glut. The market response to a global savings glut ought to have been sharply negative real interest rates for low risk savers. But as a society, we resent and resist that capitalist outcome. It is well and good for markets to drive the price of undifferentiated labor asymptotically towards zero. But God forbid that "savers" not be paid for supplying a factor that turns out not to be scarce. Instead, an alphabet soup of financial innovations was conjured to transform bad lending into demand for low risk money, and thereby support its price. Now those innovations have failed, and the fact of negative real interest rates is plainly before us. But we are still, desperately, resisting it.


Ideally, a special class of borrowers, entrepreneurs, would invest borrowed funds in projects precisely designed to meet savers' future consumption requirements. But in a sufficiently unequal society, the marginal saver may have vastly more wealth than is necessary to endow her own future consumption (including proximate bequests). There may be lots of ways to turn today's resources into "future wealth" in a general sense, but goods and services in excess of what today's lenders will be able to consume or reinvest in future periods are worthless to the people who set the price of money. The marginal productivity of investment may remain high technologically even as its marginal productivity to existing lenders turns sharply negative. (More accurately, both the marginal present and future dollar may have no consumption value to a lender, but in a accounting terms the value of a present dollar is fixed, while the relative value of a future dollar is flexible as long as there is inflation or some other means of circumventing the nominal zero bound.) It is the marginal productivity of investment to existing lenders that sets a floor beneath market interest rates. If we posit satiable consumption and sufficient inequality, market interest rates can approach -100% even while technologically fruitful projects go unfunded, because the projects would be of benefit only to people with little to offer the marginal lender.


Our current negative real interest rates are not an aberration, but a product of longstanding and continuing trends. However, since neither those trends nor the negative rates are conducive a decent and prosperous society, it is foolish to refer to them as "natural". We need to alter the circumstances under which full-employment requires that lenders pay borrowers to spend. We need to reshape "nature" until the new natural rate is positive. We need to understand the circumstances that lead investors to accept negative real returns rather than finance new ventures. We have to think about issues like income and wealth inequality, the structure of labor markets, institutional investor incentives, financial risk-aversion and deleveraging. We need to transform existing institutions, or invent new ones.

(my emphasis)

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Mon Nov 18th, 2013 at 06:01:09 AM EST

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