When a central bank tries to manipulate interest rates, there is a huge hidden cost. Interest rates are set by the market. Just because a central bank issues all the money does not mean they can set interest rates to whatever they want without any extraneous effects. Money represents wealth. If you try to set interest rates to a certain level, there will be unintended consequences. I have been thinking about this, and have come to the following line of thought. At the most basic level, money represents land, and interest rates represent the rent on that land. If you consider what these central banks hold as their reserve assets to back the money, much of it is equity in residential mortgages - essentially an indirect form of land ownership. Rents are determined by supply and demand. If a central bank attempts to artificially lower interest rates, it will affect the market price of land, not the level of rent. The price of land will go up in proportion to the artificial reduction in interest rate. If buyers can borrow more money at reduced cost, they will bid up the price of land. Of course, it will be the central bank(s) that will hold much of the equity in this land. They are using this equity to back all the new money in circulation. The central bank can issue as much money as it wants, but where does it get the wealth to this? Even if the interest rate is small, there still has to be an immense transfer of wealth going on because the economy is so huge. The answer, as you no doubt suspected, is inflation. So think, what would a situation have to look like for there to be the same effects of inflation without an actual devalueing of the money supply? In other words, what is the corresponding effects of inflation on the holding of wealth? Here is the answer: First, the central bank would confiscate a percentage of the money from everyone that held actual paper notes. Second, and a little more difficult to understand, all taxes would be increased and the central bank would now get a portion of these taxes. How is this? Because with reduced value of each note, the quantity of notes collected in taxation increases. Taxpayers need more money to pay their taxes, and the central bank issuing the new money has diverted some of the buying power to itself. (I have discuseed this in more detail in this thread: http://www.politicalforum.com/economics-trade/254643-inflation-augments-taxation.html ) The point of this thread is that a central bank setting interest rates has huge economic consequences, and these policies deserve more attention. Monetary policy should not be completely insulated from politics. The policies a central bank pursues will benefit some people and cost others. The effects are just as important as taxation.
The use of bank independence is an important feature, ensuring credible policy and reducing short termism (as simple rules are followed). The real issue is the exaggerated importance of monetary policy, with fiscal policy sidelined by the influence of the cretinous right wing
Does anyone realize what is going on?!? Vast amounts of taxpayer wealth is being diverted so that interest rates can be manipulated. It costs a huge amount of money for the central bank to set market interest rates, and they get this money through inflation, through the devaluing of the monetary notes they have issued. They are taking away purchasing power from the government. It is as though vast amounts of this taxpayer money is being diverted, just so the central bank can play its games. No wonder there is a budget deficit! No wonder the government has to keep borrowing more money. Because the money they have collected is no longer enough to pay their costs. Do Keynesian economists realize how much their policies actually cost?
The business cycle is a positive feedback loop. Growth supports more growth until it reaches a peak. Then there is a contraction, people are laid off, those that aren't start saving instead of spending, causing more lay offs, creating a recession. Interest rates are counter cyclical, and temper the business cycle. Growth requires money, both to grow business and to buy products. As money is moved from savings to purchases, interests increase, slowing growth. When business slows, money is moved back into savings, and interest rates fall. Lower interest rates allows consumers and business to borrow, boosting the economy. Because of the speed the economy can react today, interest rates as a control are more important now than ever. To lower rates, money must be added to the system. That alone fuels growth. Compound that with lower interest rates, the consumer and business go on a spending spree. Keep rates low, and businesses keep growing. Goods and services that aren't viable at normal interest rates become viable. Products that can't react quickly like housing, increase in price - but at a low interest rate, don't increase in cost. When the crash comes, it come on hard.... Just like it did. And, the lowering of interest rates that allows a recovers is really hard when they are too low to start with. Then what motivates mucking with interest rates? Money and control. The ride up brings lots of money into the government, to politicians, and to regulators. The crash bring them power. No.
I note of course that, to the vacuous question posed, you didn't even bother with content. The trouble is we have too many Austrian wannabes on here, using vacuous material from mises.org to hide from the actual debates between the competing schools. The Austrians? Zero understanding of the labour market and an understanding of firm behaviour that makes the neoclassical orthodox look advanced. They have no means to understand economic outcome so, rather than attempting to 'win' debates, they manipulate the right wing herd
That is the theory, but not everyone agrees with it. To me, it seems like a very non-focused way to try to solve a problem, like throwing huge amounts of money everywhere hoping it will fix things. You talk about "control" of the economy, but what type of control? What exactly are you trying to do?? Please do not use vague terms like "expanding the economy". If you do not have a clear idea of what you are talking about, you can do severe damage. But how? It's just moving money from one place to another. This I believe is the big fallacy held by Keynesian economists, and it's a dangerous one. How much wealth is being wasted, I do not even know! Do you really think low interest rates are just some magical formula for economic recovery?!? I just see all this money being wasted, and do not understand why the money is not more targeted.
Just repetition of error. The focus on interest rates isn't Keynesian. Indeed, it has more to do with monetarism given the focus of central bank rules is on inflation
QUOTE=Not Amused;1062798441] Because of the speed the economy can react today, interest rates as a control are more important now than ever.[/QUOTE] The control is the cost of money. When I start a new business, or launch a new product, I estimate what the cost will be, what the selling price will be and what the set up cost is. I need to make enough profit to pay off the start up cost, and the interest on the start up money. With a very low interest rate, profits can be lower, many opportunities can be launched - the economy booms. As interest rates go up, profits must go up. Only the most conservative opportunities are launched - the economy slows. The "control" is the amount of money in the bank. Banks create money out of thin air. You deposit $1000, the bank loans me $900, and I buy something from you for $900, and you deposit it - $900 of your $1900 is vaporware. When you deposit $900, the bank can loan $810 - keep going, and the bank can loan $9000 on your $1000 - all vaporware. That assumes 10% reserve - at a 3% reserve..... The larger the reserve, the higher the interest rate the bank needs to remain profitable. Government regulation sets the reserve rate - lower it, and you can stimulate the economy The Fed sets the interest rate (for their buddies the government), lowering it can stimulate the economy Both can raise "aggregate demand".
Over stimulate the economy, and you'll get a boom, always followed by a bust. Try to extend a boom, or stall the bust, by lower interest rates, you'll end up with a bigger bust.
You mean like the Taylor rule? Not so effective anymore. The problem with using inflation to control interest is that inflation due to one countries interest rates are less likely in a global marketplace. Did prices go up during the tech bubble? Not really, because competitors hold prices low, and capture market share. During the housing bubble, other than gasoline (global demand) and houses (long lead time), prices stayed pretty flat due global competition.
You're only stating that there are numerous factors impacting on price rates. Bit obvious really. However, there is nothing to discount the obvious: that interest rates are primarily motivated by inflation rate control. Its essentially a bastardisation of monetarism. Nearly some irony in that, given monetarism itself was a result of insipid debate with bastardised Keynesianism. Lots of bastardisation going on!
Bastardisation? Or the problem with monetarism applied to a country in a global economy? You say it is obvious, which it is, but then make a statement that shows you miss the point. Who is doing the bastardisation? Economists? if so, why? If not politicians, why not? (and you can forgo your usual whining about the right - both sides of the isle have their fingers in this).
Indeed, making it alien to Keynesianism and tearing the OP apart. Its unity between economist and politician. The economist maintains a convenient orthodox and the politician gets an easy rule to follow
Only if you freeze in the past, where Keynes only thinks government can increases aggregate demand by direct spending. In time, I'm sure he would have got the hang of manipulating interest rates. Mucking with interest rates sure isn't an Austrian solution. Sounds like Keynesianism.
I don't understand what you're trying to say. The opening poster is on a Keynesian whinge, not realising that the interest rate rule is an off-shoot of monetarism (and therefore alien to the Keynesian approach) Austrians have no solutions. They understand too little of the economy to be relevant. They're on a par with Georgists, typically irrelevant to economic analysis but quite capable in manipulating the gullible. Nope, given the economist isn't Keynesian and the politician is just right wing
Being much of the worlds economy was locked together by the gold standard, and the central banks did such a bang up job dealing with the Great Depression, Keynes's "solution" was for the government to increase spending to maintain the same aggregate demand. I'm sure Keynes was smart enough to understand the ability of monetarism to increase aggregate demand. You don't think so? Understanding that a boom causes a bust had no relevance to Keynes, so it doesn't to the rest of us. Left wing politicians never follow easy rules? Never throw money at a problem? ROTFL.
Keynes approach was focused on the impact of uncertainty (using tools such as behavioural economics). Monetarism was the result of a false debate over the Phillips Curve. Nothing to do with Keynes. Again you don't reply to the post quoted. Try again: Austrians have no solutions. They understand too little of the economy to be relevant. They're on a par with Georgists, typically irrelevant to economic analysis but quite capable in manipulating the gullible. Just more vacuousness! "Sounds like Keynesianism" makes no sense, given the economics involved and the adoption of the simple rule through inflationary (monetarism) concern
Created by neo-liberalism? You can't blame Keynesians for that. They did of course predict the negative effects of austerity
With $1T+ in deficit spending, where is the "austerity" in the US? But, where is this Keynesian recovery deficit spending is supposed to create? Only 195K jobs, when 450K is required just to tread water. Maybe we need to deficit spend $2T or, $4T, or $100T $100T, yeah, that's the ticket. We'll all be rich, just like all the other hyper inflated economies. Wheelbarrows full of money - woo hoo!
Perhaps the US hasn't been so dogmatic? Austerity has been shown to stunt growth and actually increase debt problems. Of course that doesn't stop the right wing supporting such foolishness
