As every economist knows, lowering interest rates stimulates business

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As every economist knows, lowering interest rates stimulates business, and raising rates inhibits business. The reason is that high rates make borrowing more expensive, so businesses are reluctant to borrow for expansion. That’s why stock prices go down when the Fed raises rates.

That is what you have been told; it is a giant steaming pile of bull dung.

Stock prices do not reflect actual business growth, or actual sales, or actual profits or actual anything.

Stock prices reflect the crowd’s anticipation of future stock prices.

We’ve written about this before, in many posts, among which are:

The dumb and dumber of negative interest rates
Low interest rates: The sneak tax on you.
The low interest rate/GDP growth fallacy

Having covered the subject in some depth, I only was moved to have another go at it when I saw the following article

Economists Mystified that Negative Interest Rates Aren’t Leading Consumers to Run Out and Spend
Posted on August 9, 2016 by Yves Smith

Not only has it been remarkable to witness the casual way in which central banks have plunged into negative interest rate terrain, based on questionable models.

Now that this experiment isn’t working out so well, the response comes troubling close to, “Well, they work in theory, so we just need to do more or wait longer to see them succeed.”

The particularly distressing part, as a new Wall Street Journal article makes clear, is that the purveyors of this snake oil talked themselves into the insane belief that negative interest rates would induce consumers to run out and spend. From the story:

Two years ago, the European Central Bank cut interest rates below zero to encourage people such as Heike Hofmann, who sells fruits and vegetables in this small city, to spend more.

Policy makers in Europe and Japan have turned to negative rates for the same reason—to stimulate their lackluster economies. Yet the results have left some economists scratching their heads. Instead of opening their wallets, many consumers and businesses are squirreling away more money.

When Ms. Hofmann heard the ECB was knocking rates below zero in June 2014, she considered it “madness” and promptly cut her spending, set aside more money and bought gold.

“I now need to save more than before to have enough to retire,” says Ms. Hofmann, 54 years old.

Recent economic data show consumers are saving more in Germany and Japan, and in Denmark, Switzerland and Sweden, three non-eurozone countries with negative rates, savings are at their highest since 1995, the year the Organization for Economic Cooperation and Development started collecting data on those countries.

Companies in Europe, the Middle East, Africa and Japan also are holding on to more cash.

And there is the key: I now need to save more than before to have enough to retire,” says Ms. Hofmann.

“Well, duh,” as the kids liked to say.  If you have saved, for instance, $1 million for your retirement, and you were earning a modest 3% on those savings, that was an additional  $30,000 per year, which plus Social Security, will help your savings last longer.

But if your savings yield $0, you’re going to need to spend less, so you can make your capital last longer.

And if you, and millions of others spend less, what happens to the economy?

Right. The economy suffers.

Gross Domestic Product (GDP) is a measure of the economy, and it also is a measure of spending — private and public — plus exports. So when spending declines, GDP growth declines.

And as we have seen, time and again, when deficit spending growth declines, we have recessions and depressions.

The article then discusses that these consumers all went on a saving binge..because demographics! because central banks did a bad job of PR! Only then does it turn to the idea that the higher savings rates were caused by negative interest rates.

The higher savings rates were caused by the lower spending rates. There are only two things you can do with any given amount of money: Save/invest or spend. All else remaining equal, when one goes down, the other goes up.

Sadly, “all else” doesn’t even remain equal, for negative interest rates cause money supply growth to fall.

How could they have believed otherwise? Do these economists all have such fat pensions that they have no idea what savings are for, or alternatively, they have their wives handle money?

People save for emergencies and retirement. Economists, who are great proponents of using central bank interest rate manipulation to create a wealth effect, fail to understand that super low rates diminish the wealth of ordinary savers.

Consider what happens to investors in T-securities. When interest rates decline, the federal government pumps fewer interest dollars into the economy, which is recessionary.

It is apparently difficult for most economists to grasp that negative interest rates reduce the value of those savings to savers by lowering the income on them.

Value = Demand/Supply.  It is one of the most basic formulas in economics. One only can wonder how it is possible for economists not to understand it. When the Demand for money is reduced, the Value of money is reduced. Could it be more obvious?

Savers are loss averse and thus are very reluctant to spend principal to compensate for reduced income. Given that central banks have driven policy interest rates into negative real interest rate terrain, this isn’t an illogical reading of their situation.

Ed Kane has estimated that low interest rates were a $300 billion per year subsidy taken from consumers and given to financial firms in the form of reduced interest income.

Since interest rates on the long end of the yield curve have fallen even further, Kane’s estimate is now probably too low.

The second effect is that of inflation signaling.

Again, consumers are reacting correctly to the message central banks are sending. Negative interest rates signal deflationary tendencies and that central banks think deflation is a real risk. And what is the rational way to behave in deflation? Hang on to your cash, because goods and services will be cheaper later.

Despite what my good friends of the Modern Monetary Theory (MMT) persuasion say, low rates encourage inflation by reducing the Demand for dollars, while high rates discourage inflation by increasing the Demand for dollars.

(MMT says high rates cause inflation by increasing costs, a hypothesis that is at odds with historical fact.) The Fed successfully has fought inflation by increasing interest rates.

Inflation is a loss in the Value of money compared to the Value of goods and services.

Value = Demand/Supply
Demand = Reward/Risk

Reward = Interest

To fight inflation, increase the Demand for money, which is accomplished by increasing the Reward for owning money, and that is done by increasing Interest.

Here we have what passes for the policy logic:

Low interest rates should encourage consumers and businesses to spend by depressing returns on savings and safe assets such as government bonds. Such spending should create demand for goods, help lift sagging inflation and boost economic growth.

Earth to economists: savings and spending may look fungible to you because they are alternative uses for income but they serve very different functions.

Once people have put enough away that they have a good reserve for emergencies and enough to have a comfortable retirement, then saving and spending can be regarded as close substitutes.

But in the US, with safe income on investments running below inflation levels, and Medicare being actively crapified, a retirement-aged couple would need over $3 million in liquid assets to allow for 20-30 years of living expenses and possible medical costs. How many are in that boat?

One of the greatest, if not the greatest, fears of retirement is outliving your money.

Now perhaps this rationalization was simply central bank patter for wanting to depress the value of their currency and spur growth through more exports.

Thus, the idea that consumers might spend more was just a convenient cover for their real aim that some economists who were not clued in took seriously.

But whatever the cause, the central bank hallelujah chorus regularly claimed that negative interest rates will lead consumers to run out on a shopping spree.

The one bit of good news in this article is that the Bank of England is not persuaded, and even though the Fed has admitted it might take up the negative interest rate experiment, it remains keen to raise rates.

Mind you, it’s not clear that this skepticism is due to greater intellectual rigor. Banks have lost safe sources of earnings with zero and negative interest rates, and are increasingly pressuring central banks to increase interest rates, even though they’ll take hits during the adjustment period.

In summary, the imposition of negative interest rate is among the least intelligent of economics ideas in a litany of unintelligent ideas that beset the “science” of economics.

It is yet another example of: “If it doesn’t work, never has worked, and can’t possibly work, do it again, only more.”

(Other examples bad economics ideas are: “Reduce deficits to grow the economy,” “Cut the federal debt to make it sustainable,” “Cut Social Security to make it last longer,” “Punish the poor to make them work harder,” “Increase interest rates to slow economic growth,” and “Reward the rich for being the ‘makers.‘”)

All have been designed and promulgated by the rich to widen the Gap between the rich and the rest.

Rodger Malcolm Mitchell
Monetary Sovereignty

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THE RECESSION CLOCK

Monetary Sovereignty
Vertical gray bars mark recessions.

Recessions begin an average of 2 years after the blue line (Federal Debt Held By The Public As A Percentage Of GDP) first dips below zero.

(A common phenomenon is for the line briefly to dip below zero, then rise above zero, before falling dramatically below zero.)

There was a brief dip below zero in 2015, followed by another dip – a familiar pre-recession pattern.

Recessions are cured by a rising red line.

As the federal deficit growth lines drop, we approach recession, which will be cured only when the growth lines rise.

Increasing federal deficit growth (aka “stimulus”) is necessary for long-term economic growth.

MONETARY SOVEREIGNTY

4 thoughts on “As every economist knows, lowering interest rates stimulates business

  1. Thanks for debunking this ZIRP stuff. We can clearly see that it hasn’t had the positive effect people were anticipating it to have, just like massive rounds of QE when it comes to monetary policy. I also think it’s pretty clear to any rational, thinking person that we desperately need much more emphasis on fiscal policy, then the FOMC at the Fed can make decisions accordingly on adjusting interest rates to fight inflation if it occurs.

    When people just repeat whatever they’ve heard and don’t ever adjust their analysis when the facts change, well that’s a major problem. It also shows me that they don’t understand basic math or statistics or accounting or anything else that would expose how poor their logic is.

    Economics as a profession is right up there with journalism with how much of it is just agenda pushing, ideological grandstanding and idiots making sh*t up for their own benefit.

    Like

  2. Just straight up Voodoo, is what the belief system behind mainstream economics ‘dung pile’ amounts to.
    It’s also as persistent as religions and as difficult to change, since logic is not involved.

    Like

  3. The “Fed Funds Rate” is indicative of how best the Federal Reserve can effect its “Dual Mandate”: Full Employment and Manageable Inflation. When the Fed is too accommodative, rates can drop too low, Deflation (the absence of any Inflation) can set-in, and can even be worse than Inflation.

    The Fed, in actuality, tries to maintain a balance: Strong Employment, along with it’ target of two percent inflation. When the Fed raises rates, that’s not to stifle the Economy, but to point-out, that with all of the data it has, the Team of (mostly) Economists, that sit on its Board, feel that the Economy can best retain that stability, with a little hike from the Feds Rate.

    Market participants don’t realize that, when the nFed cuts rates, it visualizes weakness up ahead. So, those who want merely rate cut, after cut, aren very short-sighted in their thinking.

    With Donald Trump trying to micro-manage Economy, I can only wonder if we might see a return to that old 1970s bugaboo–Stagflation.

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    1. Yes, though the dual mandate is official, it also is nuts. Making the Fed responsible for full employment is like making my bank responsible for my company’s profits.

      Employment is a direct function of the economy, and if Congress and the President aren’t responsible for the economy, what the heck are they responsible for?

      Clearly, Congress and the President are trying to relieve themselves of the responsibility they were elected to take on.

      Aside from keeping the banking system running, the Fed has one key responsibility — inflation — which they control via interest rates.

      Like

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