The Economist Has No Clothes

Negative Interest Rates

This is what Greg Mankiw, former adviser to George W Bush has come up with as a solution to the economic crisis.

A fine example of post-modern thought, it has the appearance of wisdom on the surface, but underneath, contains poison.

Inspired by socialist Karl Marx admirer Silvio Gesell, a pseudo-economist, the idea would force citizens to spend money they saved or be punished by its devaluation.

Some excerpts from the article:

What is the best way for an economy to escape a recession?

Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services — and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

So why shouldn't the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent?

At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand.

The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less.

Unless, that is, we figure out a way to make holding money less attractive.

If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.

Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.

It is interesting to look carefully and make note of the underlying assumptions Mr. Mankiw makes about the nature of human beings and the role of government in society.

1) People should not be allowed to make purchase or savings decisions for themselves.

How do I reach this conclusion? Mr. Mankiw assumes that "we" - that is government officials and advisers, must get the economy moving again by forcing people to spend when their natural reaction to a downturn is to save. People who save during adversity are behaving rationally. There have been excesses in spending and investing that need to be corrected. This is not something that needs correcting by government, as it is part of a natural cycle just as winter follows autumn.

2) That a central bank should exist in the first place. If we look back in history, we find that central banks were only created in the early 1900's. Once the gold standard was eliminated in most countries in the 1930s, central banks with fiat currencies established their stranglehold on the money supply. Prior to central banking, inflation was a phenomenon that rarely persisted. Since central banking and its tinkering with interest rates, inflation has become a pox on us all.

3) Individual civil liberties are of little importance if "the State" has a particular economic goal to achieve. If we want, say 4% GDP growth, we just use negative interest rates or currency with an expiry date to coerce the public to spend their money. Silvio Gesell was particularly emphatic on the idea of expiry dates and depreciating values of currency. His book "The Natural Economic Order (1934)" elaborates these ideas of what is essentially a hybrid between communism and industrial capitalism. Perhaps of more importance is Gesell's influence on John Maynard Keynes who quoted him extensively in his famous work "General Theory of Employment, Interest, and Money (1936)".

Without a tangible standard for monetary policy, be it gold, silver, copper or something else, there is no anchor or ultimate accountability on the part of the State.

The State can print paper currency without restraint, as there is no convertibility to a tangible material. And we know the path that will lead us down the blind alley of severe, persistent inflation. As Milton Friedman taught us, "inflation is only, always, a monetary phenomenon".

This type of thinking troubles me as the implications for society are quite dark. Every administration will "come to the rescue" of the economy for the public good, and trample our freedoms in the process by expanding government powers over our lives. President Obama's chief of staff Rahm Emanuel's famous quote, "Never let a crisis go to waste," speaks to the real and present threat that already exists.

Perhaps Karl Marx's vision of the socialist State will succeed after all, through these back door methods instead of direct revolution.