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Source link: http://archive.mises.org/9851/the-nuttiness-of-negative-interest-rates/

The Nuttiness of Negative Interest Rates

April 27, 2009 by

In his April 18 New York Times op-ed, Harvard professor (and Bush adviser) Greg Mankiw calls on the Federal Reserve to promise future inflation, in order to fix the economy. Mankiw’s article beautifully illustrates what is wrong with today’s economics profession: it consists of very sharp guys (and gals) who can develop interesting models that spit out policy recommendations that would destroy the economy. FULL ARTICLE


Dennis April 27, 2009 at 8:12 am

“Mankiw’s article beautifully illustrates what is wrong with today’s economics profession: it consists of very sharp guys (and gals) who can develop interesting models that spit out policy recommendations that would destroy the economy.”

This observation is absolutely correct. I would add that while the mainstream economics profession’s policy recommendations would destroy the economy, the power, prestige, career opportunities, and monetary compensation of its members is considerably advanced by its support of increasing interventionism, fascism, and socialism. I cannot help believe that this is a major factor that has influenced the direction of mainstream economics since the early 20th century. The phrase “court economists” accurately describes the mainstream profession.

Look at what speaking truth to power did to the academic careers of Mises and Rothbard, two extremely intelligent and productive individuals. Hayek’s career fared only modestly better.

greg April 27, 2009 at 9:08 am

I think economist are putting too much emphasis on the impact of the Fed Funds rate.

For example, I bought some land a couple years ago at 5% (prime minus adjustable). Today I am paying 2.5% on the same loan. With the interest rate down, I should be looking for additional land, but I am not. Why? It is because other market conditions drive my decision to add to my land holdings.

Interest is just a cost of doing business that I build into the price I sell my product for. What I look at is the amount of cash I need to put down and the return on that cash when I sell. Typically, I put $25,000 down and make $250,000 on each sale. A 1% move in the interest rate only effects my bottom line by $10,000.

The Fed Funds rate does have a short term effect on the markets, in most cases it last about an hour. The market is looking at the larger picture.

Lets look at gold, everyone’s favorite commodity. With low rates and the increase in M1, why hasn’t gold’s price increased. The answer is that the market is looking beyond interest rate and money supply. A major concern of all those that invest in gold is the chance that a central bank somewhere will sell part of their reserves. There is a loose agreement between central banks that they will not dump gold on the market, but if the price goes to $1500 an ounce, maybe someone will break.

The market is a collection of individual actions that adapt to changes that cannot be predicted by past actions.

dewind April 27, 2009 at 9:11 am

What perturbs me more than anything is that they gleefully play with and experiment on our currency. The indirect effects of meddling in our currency leads to the destruction of wealth to which they will probably shrug their shoulders and say, “Well, at least we tried.”

Jonathan Finegold Catalán April 27, 2009 at 9:45 am


I think you’re partially correct that there are events outside of interest rates which dictate investment. For example, business outlook on the future does take a part, which is why investment remained low throughout the Great Depression—businesses did not look towards investing when they were not guaranteed that they could profit off their investment.

But, your example contradicts your own point. Nobody is talking about an immediate “change of heart”. In other words, somebody buying a house may not immediately say, “Gee, interest rates are low, I should buy some land.” Your example only applies to your point that interest rates effect the market “only about an hour after” (which is a completely arbitrary time period, which I’m sure that you just made up).

Furthermore, the markets most effected, as shown by Murray Rothbard in America’s Great Depression, is not that of the finished good itself (let’s say, housing), but the industrial-goods necessary for the durable finished good (goods that require more savings to purchase, which normally result in lower interest rates; in this case, the savings do not really exist and the interest rates are held artificially low).

So, I’ll use your thesis against you. Robert Murphy is not looking at the short term effects, he is looking at the long term effects of low interest rates. Obviously, given the length of the boom, the effects are not immediate.

Robert C April 27, 2009 at 12:07 pm

On the bright side, I no longer feel all that bad about my extremely slim chance of being admitted to the Harvard PhD program.

Brede Armozel April 27, 2009 at 1:16 pm

I think we’re seeing the full intellectual bankruptcy of the Neo-Classical and Keynesian schools. And sadly, it’s not pretty.

The question for me is: can we get out of it in one piece?

Inquisitor April 27, 2009 at 2:07 pm

The “grad student’s” suggestion struck me as something out of Alice in Wonderland, either from the Mad Hatter or from the insane Queen of cards toward the end. Off with those dollars!

gabe April 27, 2009 at 2:15 pm

It Seems like this news from a month ago should have a little more attention than it does. Should the “accident” be investigated a little more deeply?


Baxter BAX is set to make a killing if we are lucky enough to get a mandantory vaccine shot for everyone in the US!

Lee Kelly April 27, 2009 at 2:42 pm

Modern macro-economists tend to be very good at what they do, but few actually know what they’re doing. Whatever that is, what it is not is economics.

David Spellman April 27, 2009 at 3:26 pm

If our goal is to make people want to part with their money and spend on commodities, Mankiw is proposing exactly the right remedy. He simply does not recognize it by its previous name: hyperinflation.

Ask yourself how in the world governments enter into the downward helix of hyperinflation? Do they decide that self destruction is a good idea? No, they decide to start printing money to pay the bills. The presumption (presumptuous and preposterous) is that the authorized counterfeiting of money can occur faster than it loses value.

Mankiw is simply proposing hyperinflation by another name. Sadly, when it comes he will not recognize his own child or take responsibility for what he desires to sire. Mankiw will get a giant game of monetary hot potato going that will spiral out of control and destroy all savings and investments.

The promise that next year’s inflation will make this year’s savings worthless will light a fire for everyone to dump their money as fast as possible. It will also naturally result in no one wanting the money at all. We can laugh about the stupidity of the proposal, but there are people who take it seriously enough to implement it, and soon.

Previous hyperinflations have occurred in the context of sounder currencies to flee to. If the Almighty Dollar is destroyed, where will we run? Could it precipitate the collapse of all meaningful commerce beyond barter? If that were to happen, what would happen to the hundreds of millions who depend upon the specialized economy and division of labor? Could civilization collapse before new methods of interchange arise?

Dick Fox April 27, 2009 at 3:31 pm

Bernanke has already created negative interest rates. Negative interest rates mean that you pay somone to take your money. When the FED pays interest on reserves and at the same time loans money to the banks at zero % interest the effect is negative interest rates. The only problem is that the whole thing is stupid. The excess money that Bernanke is trying to use to “stimulate” the economy just sits in reserves drawing interest so the whole exercise is silly.

But when the door opens and all that money floods into the economy you better have an Ark ready. God sent the rainbow to let us know that the earth would never be flooded with water again, but he never said anything about a flood of dollars.

AC April 27, 2009 at 4:40 pm

A couple points. Prof. Mankiw called the grad student’s proposal “clever.” I call it, theft. If that’s the crap coming out of Harvard PhD econ programs, it’s no wonder so many ivy league PhD’s end up working for the gov’t in some capacity. The private sector has no use for it, especially since it usually gets in trouble if it tries to steal people’s wealth. Now with a fascistic gov’t/private sector, I think things can potentially get a lot worse.

I doubt most regular folks working hard every day realize that wages are generally the last thing to increase in an inflationary environment. People are literally going to get poorer by the day with fools and thieves running a command and control economy that we’re quickly marching toward

Well, I’d like to protect what meager net worth I have. If only I knew what the Fed and the US Treasury and Congress was going to do next. I’m real close to deciding to go into major debt (negative net worth) to purchase investments that should do well in a highly inflationary environment, re-mortgage house, run up open credit lines, etc. That way after the massive wave of inflation hits, I’ll cash out the investments, payoff the devalued debt, take the extra and do something else with it. I’m a little leary of gold, since the Fed can play games with the price by selling large quantities on the open market. How about, other metals, like copper, and maybe some other commodities. What investments will respond quickly to inflation, that the Fed has traditionally not been involved in?

R. Thomas Harding April 27, 2009 at 6:59 pm

Trying to figure out what the effect of the Fed’s policies will mean in the near and distant future is always a challenge and often quite puzzling. When one considers the recent policy of their pumping up the available cash to get banks to lend more it’s easy to see that they believe that the flow of cash will help solve the recession. However, they then agreed to pay member banks interest on the money they aren’t lending. So, where’s the incentive to lend when the banks can get free money and get paid to keep it?

It’s a puzzlement!

Gerry Flaychy April 27, 2009 at 9:06 pm

” Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent. ” Greg Mankiw

A year give more than enough time to everybody to put every currency they have in their bank account and pay everything with account-money, that is to say with debit cards, credit cards, checks, bank mandates, transfers by computer directly from home, and … coins !

Student: 0% !

Teacher: 0% !!

jeffrey April 27, 2009 at 9:07 pm
Jeff Harding April 27, 2009 at 11:31 pm

I think that the grad student is set to be a brilliant young rising star in the Washington-Harvard-MIT world of economics. Only in that world would confiscation of assets directly and indirectly through inflation make sense. Wouldn’t it be simpler to just give everyone a $100,000 stipend if they think stimulus works?

gene April 27, 2009 at 11:38 pm

There is no telling what will happen, the genie is out of the bottle and the can of worms has been opened.

One thing I always keep in mind is “If it all goes down the tubes, there is [paradoxically] nothing to worry about, everyone will be in the same boat! and maybe boat isn’t that far off!

If we get hyperinflation, then we are also in the same boat, you just want to own the boat so you have some hedge.

If what you do has some real value, you will at least have a job. So if you are an economist, maybe keep a back up plan!!!

Carlos C Tapang April 28, 2009 at 4:10 am

The Fed will not be able to manipulate the price of gold when the chickens come home to roost. There’s just not enough of the yellow metal to cover all the money that’s been released. I found a figure in wikipedia.org as to the value of all gold mined so far in the world, and using the February peak price, the total value amounts to only about 4 trillion dollars (give or take hundreds of billions).

fundamentalist April 28, 2009 at 8:19 am

Mankiw later wrote that the grad student’s proposal was tongue-in-cheek. Still, it demonstrates the ridiculous conclusions that people will make when they are obsesses with consumer demand and nothing else whatsoever.

What will happen with these extremely low interest rates is that few businesses will borrow to produce more because of the uncertainty created by the Feds, but a lot of people will borrow to invest in cheap assets, like the stock market, or some form of the carry trade.

Mark D. Hughes April 28, 2009 at 10:30 am

Another fabulous Robert Murphy article.

I have one small praxeological quibble though:

“…short-term interest rates need to rise dramatically. It is analogous to the prices of flashlights and canned food during a hurricane that knocks down power lines. The price needs to shoot up in order to ration the available units to those who need them the most.”

Your phrase “those who need them the most” is a value judgment. Wouldn’t it be more accurate to say “those willing to pay the highest price which implies there most highly valued use.”

gene April 28, 2009 at 10:33 am

A lot of past economists would agree with fundamentalist. When the Fed is gushing dollars, the excess often goes to paper, rather than production. This is what the housing bubble was and I think the Fed hopes to replicate it.

The problem I think, is what needs to happen is exactly what our “leaders” are trying to prevent from happening. The fat needs to be trimmed and the economy will get back to real production and values, but the fat is what they want to save, since they are the fat.

Guillermo Barba April 28, 2009 at 11:03 am

Prof. Murphy,
In your excellent article you say: “After a Fed- induced boom, workers and other resouces need to shift from the bloated sectors into the industries that were starved during the boom.”
Will you please give examples of those ‘starved’ sectors and evidence that there were ‘deprived’ as well as the present rammifications?

Sonic Ninja Kitty April 28, 2009 at 5:57 pm

Thank you Prof. Murphy. Your explanations are clear and logical–it’s a real gift you have. Your rebuttals of various NYT columns are especially helpful to those of us trying to fight the malinformation war out here at the grassroots level.

Sumant Rawat April 30, 2009 at 5:11 pm

Its too bad that Austrian Schoolers have no sense of humor but there is a grain of truth in the madness.The world is logical in the middle but at the extremes gaussian means disappear and black swans rule the roost.Relativity and quantum theory similarly defy the logical mechanistic view of common sense so it seems we are all at the Mad Hatters party and we may as well drink and enjoy the tea!

SG May 18, 2009 at 7:57 am

I wonder if there are any good macro books around?

Does anybody know alternatives to mainstream authors?

Adriaan Koreman November 3, 2010 at 1:16 pm

The New ‘Das Kapital’.

Too many people believe that FREE MARKET ECONOMY and CAPITALISM is one and the same thing, as opposed by COMMUNISM.

Communism is nothing more than a philosophy originating from a study of the poor living conditions of workers during the industrial revolution.

Capitalism is nothing more than a monetary system originating from the use of gold and later deposit slips for gold as a means of exchange.

But Free Market Economy is a natural way of bringing offer and demand in balance that already existed in the time of barter trade.

Capitalism exploits labour to create added value …. or so Karl Marx said.

But let’s face it ….. The only real existing value in this world is LABOUR! Nothing can be achieved without it. No raw materials can be extracted from the earth without labour …… No food can be produced …… No added value can be created….. No profits can be achieved …… Nothing! On the other hand …… CAPITAL has no real value at all. You can’t eat it. In Mugabe’s Zimbabwe, they burn CAPITAL (paper money) because it is cheaper than firewood!

Contrary to popular believe: Money is TIME! When you earn money, you have given your time in producing something … in rendering a service of some kind … in trading something ….. or whatever ….. and received money for that! This money allows you to buy TIME from somebody else. You can buy a product that someone created with his time … a service ….. you name it. It is always TIME that you buy! Part of the time that you can buy for your money has already been transferred into products. A car waiting to be sold ….. Food in the supermarket …… Tools of some kind …… A house…. But services still to be rendered ….. products not yet created …… are still in their basic form of available TIME! So when unemployment is skyrocketing we should be so happy! There is so much TIME available! What richness! What wealth for a nation! But are we happy with high unemployment?

TIME when it is not consumed loses it’s value. At a rate of 100 % per day. We are used to transfer the time that we are owed into CAPITAL in order to be able to transfer it back into TIME when we want to buy something or invest it. CAPITAL keeps, but TIME doesn’t!

In order to persuade someone to invest his capital he wants interest or profit of 4 % or more or he hangs on to his capital. In order to persuade someone to invest his time in a period of unemployment you can give that person less than what he needs to survive and he will still sell you his time. Something is better than nothing!

And that is how capitalism is able to exploit labour to create added value. By transferring time owed into CAPITAL and only buying time back when it can make a profit, allowing TIME or LABOUR to be completely lost when it is thought that no added value can be created with it. High unemployment, poverty and crises are the flaws of CAPITALISM. Not of the FREE MARKET! Without transferring the time that we are owed into CAPITAL and having to consume that time without too much delay we would still have a FREE MARKET ECONOMY, but we would not have CAPITALISM!

So how can we have a Free Market Economy without the flaws of Capitalism?

Barter trade? Of course not! We live in the 3rd millennium! Even though we still use a money system from the 1st or 2nd millennium! If CAPITAL or MONEY is to be a means of exchange for TIME, then it should have the same property as TIME! Meaning … it should lose value when it is not consumed within a certain period, just as TIME does! But how to achieve that?

Nothing is easier. Let’s look at one possibility: Substitute V(alue) A(dded) T(ax), which is a punishment for transferring labour into added value, by V(alue) D(iminished) T(ax) on money in possession as long as it is not used. A negative interest Tax on money. For that we would have to change cash money into digital money in our bank account. But hey! We pay with pin, credit card, chip, cheque, internet, mobile phone ….. We are in the 3rd millennium! Substituting VAT by VDT will certainly make us all a lot richer. As TIME or LABOUR is the only real value that exists we cannot accept a monetary system like CAPITALISM that allows it to go to waste.

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