Low interest rates: the original fiscal stimulus

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Main Question or Discussion Point

Now that it seems like the popularity of conservatism is growing with resistance to fiscal stimulus spending associated with the democratic party, the question becomes what will happen with interest rates. It seems like rising interest rates used to be associated with democrats in the white house. I don't know if this was coincidence or if there was political logic in it. Certainly the logic that lowering interest rates promotes business makes it seem like a republican economic strategy, but isn't it just a form of fiscal stimulus that works by promoting real-estate appreciation in the present at the expense of greater debt in the long-term?

Either way, it shouldn't matter because whatever stimulus was to be had from lowering interest rates seems to have long been milked, drained, and for the last few years, it has just become a means for borrowers to lock in merciful rates in the event that rates would start rising again. The question is whether the revitalization of the republican party in politics is going to include the strategy of maintaining low interest rates or if free-marketism may actually be allowed to foster a situation in which defaults grow causing banks to raise interest rates as a means of making lending for depreciated properties more lucrative/attractive.

Also, if you expect interest rates to begin rising soon, how do you expect party ideologies to respond and how quickly or slowly do you think they can and will rise, and to what level?
 

Answers and Replies

  • #2
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It's not that simple. Dropping interest rates to stimulate loans is one thing - artificially suppressing interest rates for a long period of time while printing money and in the presence of escalating deficits is another.

http://www.creditwritedowns.com/2010/10/on-liquidity-traps-and-quantitative-easing.html#

"When the Fed Funds rate is essentially zero, the Federal Government does not have to issue any bonds at all (except as mandated by Congress to ‘fund’ deficit spending). In reality, when rates are zero, the Fed could simply monetize the deficits and it would be functionally equivalent. What this means is that there is no difference between quantitative easing and issuing short-duration treasury bills. Paul Krugman recently pointed this out in an essay, saying:

The point is that we’re now in a liquidity trap. What does that mean? It means that the Fed has pushed short rates down to zero, so that at the margin T-bills are no better than cash — and correspondingly, that means that at at the margin people and banks are holding some of their cash purely as a store of value. Liquidity is now free, and as a result the market’s demand for liquidity is satiated; adding more potentially liquid assets makes no difference. So issuing short-term debt and printing monetary base are equivalent.

But, you say, it won’t always be thus: at some point the economy will recover to the point where the zero lower bound is no longer binding; and at that point monetary base and short-term debt will no longer be the same thing. Indeed. But at that point the Fed will be seeking to reduce the monetary base — by definition: it’s only once the Fed is trying to curb the size of the base that the zero lower bound ceases to be binding."


Once interest rates are allowed to rise, we could be faced with high inflation - this wil be bad for either party (whoever is in power).
 
  • #3
503
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It's not that simple. Dropping interest rates to stimulate loans is one thing - artificially suppressing interest rates for a long period of time while printing money and in the presence of escalating deficits is another.

http://www.creditwritedowns.com/2010/10/on-liquidity-traps-and-quantitative-easing.html#

"When the Fed Funds rate is essentially zero, the Federal Government does not have to issue any bonds at all (except as mandated by Congress to ‘fund’ deficit spending). In reality, when rates are zero, the Fed could simply monetize the deficits and it would be functionally equivalent. What this means is that there is no difference between quantitative easing and issuing short-duration treasury bills. Paul Krugman recently pointed this out in an essay, saying:

The point is that we’re now in a liquidity trap. What does that mean? It means that the Fed has pushed short rates down to zero, so that at the margin T-bills are no better than cash — and correspondingly, that means that at at the margin people and banks are holding some of their cash purely as a store of value. Liquidity is now free, and as a result the market’s demand for liquidity is satiated; adding more potentially liquid assets makes no difference. So issuing short-term debt and printing monetary base are equivalent.

But, you say, it won’t always be thus: at some point the economy will recover to the point where the zero lower bound is no longer binding; and at that point monetary base and short-term debt will no longer be the same thing. Indeed. But at that point the Fed will be seeking to reduce the monetary base — by definition: it’s only once the Fed is trying to curb the size of the base that the zero lower bound ceases to be binding."


Once interest rates are allowed to rise, we could be faced with high inflation - this wil be bad for either party (whoever is in power).
How is liquidity free if you have to repay the loan? You can't just keep "borrowing from Peter to pay Paul" forever, so to speak. Gradually, at least, you have to reduce your expenditures to the point of paying off debt without substituting it with new debt, right? Otherwise you would be permanently mired in debt.

I don't know if rising interest rates will be bad for political parties. There might be so many people waiting on their savings to pay them retirement income that rising interest rates would actually make a party popular. When the baby-boom generation was young, it was popular to make it cheap to borrow money but now that they're retiring, they would probably rather benefit more from their savings.

Given so many years of low interest rates and the ability to refinance to lock in the low rates for the long term, are there still people who would be caught off-guard if interest rates started rising?
 
  • #4
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How is liquidity free if you have to repay the loan? You can't just keep "borrowing from Peter to pay Paul" forever, so to speak. Gradually, at least, you have to reduce your expenditures to the point of paying off debt without substituting it with new debt, right? Otherwise you would be permanently mired in debt.

I don't know if rising interest rates will be bad for political parties. There might be so many people waiting on their savings to pay them retirement income that rising interest rates would actually make a party popular. When the baby-boom generation was young, it was popular to make it cheap to borrow money but now that they're retiring, they would probably rather benefit more from their savings.

Given so many years of low interest rates and the ability to refinance to lock in the low rates for the long term, are there still people who would be caught off-guard if interest rates started rising?
What if a 3% move in interest rates triggers 3% (to 15%?) inflation?
 
  • #5
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What if a 3% move in interest rates triggers 3% (to 15%?) inflation?
1) why/how would it do that?
2) what measures are available to counteract inflationary pressures? Could increasing reserve requirements indeed help? Could anti-trust and other competition-stimulating measures keep prices in check?
3) if inflation increased by 3%-15% while interest rates were also increasing, the two would come into conflict because people with mortgages would be getting squeezed from both ends. Their mortgage payment would be increasing while their grocery bill was increasing as well. This would mean either housing prices would have to be more competitive to be afforded, or other prices would have to be more competitive, or both. Isn't the whole point of economics that people have to make choices because they can't buy everything?
 
  • #6
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1) why/how would it do that?
2) what measures are available to counteract inflationary pressures? Could increasing reserve requirements indeed help? Could anti-trust and other competition-stimulating measures keep prices in check?
3) if inflation increased by 3%-15% while interest rates were also increasing, the two would come into conflict because people with mortgages would be getting squeezed from both ends. Their mortgage payment would be increasing while their grocery bill was increasing as well. This would mean either housing prices would have to be more competitive to be afforded, or other prices would have to be more competitive, or both. Isn't the whole point of economics that people have to make choices because they can't buy everything?
1.) An interest rates increase will impact costs.
2.) Interest rates are being artificially suppressed now.
3.) We don't know how much inflation might accompany?
 
  • #7
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1.) An interest rates increase will impact costs.
You're assuming that costs can be limitlessly transferred to the consumer through price-increases, but what happens is that consumers get pressed to cut more and more out of their budgets because businesses are trying to pass all those costs to them instead of negotiating their operating costs downward. You can't endlessly avoid cutting business costs internally by lowering interest rates, raising prices, and otherwise fiscally stimulating business. At some point, people at every level of business have to adjust their incomes downward. The more uniformly this occurs, the less layoffs and other widening of the gap between employed and unemployed.

2.) Interest rates are being artificially suppressed now.
Yes, but what is being done to counteract inflationary tendencies? There are other forms of economic intervention besides fiscal and monetary policies. Businesses don't like price-competition stimulus like anti-trust, because it reduces revenues, but wouldn't it be nice if for once business could put long-term prosperity over short-term gain?

3.) We don't know how much inflation might accompany?
What is this supposed to mean?
 
  • #8
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You're assuming that costs can be limitlessly transferred to the consumer through price-increases, but what happens is that consumers get pressed to cut more and more out of their budgets because businesses are trying to pass all those costs to them instead of negotiating their operating costs downward. You can't endlessly avoid cutting business costs internally by lowering interest rates, raising prices, and otherwise fiscally stimulating business. At some point, people at every level of business have to adjust their incomes downward. The more uniformly this occurs, the less layoffs and other widening of the gap between employed and unemployed.


Yes, but what is being done to counteract inflationary tendencies? There are other forms of economic intervention besides fiscal and monetary policies. Businesses don't like price-competition stimulus like anti-trust, because it reduces revenues, but wouldn't it be nice if for once business could put long-term prosperity over short-term gain?


What is this supposed to mean?
When the cost of capital increases - prices will increase - we don't know how much.
 
  • #9
mheslep
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... but isn't it just a form of fiscal stimulus that works by promoting real-estate appreciation in the present at the expense of greater debt in the long-term?
No. Interest rate decreases are indeed an attempt at stimulus, but a http://en.wikipedia.org/wiki/Monetary_policy" [Broken].
 
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  • #10
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When the cost of capital increases - prices will increase - we don't know how much.
That may well be the case, but the question is whether it should pose a deterrent to raising interest rates. Obviously, businesses will attempt to compensate for increased costs by raising prices, at least at first, but they will only be able to avoid budging if there is sufficient solidarity among them to avert price competition. The other possibility is, of course, that there is enough surplus income for most consumers to handle more inflation, in which case consumption patterns will not blink at the rising prices.

How can they avoid raising interest rates permanently, though? Without raising interest rates, what possibility is there for lowering them as an instrument of economic correction? You have to let up on the gas pedal once in a while if you want to have any room to accelerate in situations that warrant it. The trick is to ease off the gas in a way that doesn't immediately cause a traffic jam or multicar pileup. That requires everyone else easing off spending as well - not just the FED, right?
 
  • #11
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That may well be the case, but the question is whether it should pose a deterrent to raising interest rates. Obviously, businesses will attempt to compensate for increased costs by raising prices, at least at first, but they will only be able to avoid budging if there is sufficient solidarity among them to avert price competition. The other possibility is, of course, that there is enough surplus income for most consumers to handle more inflation, in which case consumption patterns will not blink at the rising prices.

How can they avoid raising interest rates permanently, though? Without raising interest rates, what possibility is there for lowering them as an instrument of economic correction? You have to let up on the gas pedal once in a while if you want to have any room to accelerate in situations that warrant it. The trick is to ease off the gas in a way that doesn't immediately cause a traffic jam or multicar pileup. That requires everyone else easing off spending as well - not just the FED, right?
As I recall from my finance classes (a few decades ago when CD's were earning 12%) - the historical average for interest rates is approx 8%.
 
  • #12
How is liquidity free if you have to repay the loan? You can't just keep "borrowing from Peter to pay Paul" forever, so to speak. Gradually, at least, you have to reduce your expenditures to the point of paying off debt without substituting it with new debt, right? Otherwise you would be permanently mired in debt.
Yeah, thats how it works! Search: "historical interest rates". Also compare these numbers to the business cycle. If you search: "recessions in the U.S.". You can compare these two.Also search "money supply" and "bailouts". This may get you closer to the answers you are looking for.
 
  • #13
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Yeah, thats how it works! Search: "historical interest rates". Also compare these numbers to the business cycle. If you search: "recessions in the U.S.". You can compare these two.Also search "money supply" and "bailouts". This may get you closer to the answers you are looking for.
Why is it that I can put forth a concrete empirical question and get a response that makes reference to a bunch of general phenomena? If you can't dissect economic behavior at the level of empirical exchanges, what is the point of macro analysis? What is it built on, what does it refer to, and how is it empirically accountable and/or applicable?
 
  • #14
Why is it that I can put forth a concrete empirical question and get a response that makes reference to a bunch of general phenomena? If you can't dissect economic behavior at the level of empirical exchanges, what is the point of macro analysis? What is it built on, what does it refer to, and how is it empirically accountable and/or applicable?
I don't understand. If the study of macroeconomics is based on data provided by trends in behavior of everyone. It is first a study of microeconomics, and macroeconomics it is just a study of everyone's individual behavior all pooled together. My answer could have been better, yes, but if you do all those searches you will see how everyone has behaved in the past.
It is also not general phenomena, all those things I mentioned directly relate to the interest rate. They all relate to each other. So let me try again.

1.How is liquidity free if you have to repay the loan? 2.You can't just keep "borrowing from Peter to pay Paul" forever, so to speak.3. Gradually, at least, you have to reduce your expenditures to the point of paying off debt without substituting it with new debt, right?4. Otherwise you would be permanently mired in debt.
1.No, it's not free.2. No you can't. 3.Yes. 4.Yes

Your question in the OP could be answered, or you would be closer anyways, if you do those searches I suggested. They all relate to the interest rate. They all are either affected by it or caused by it.
 
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  • #15
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How is liquidity free if you have to repay the loan?
It's a short term and situational phenomenon. They are printing money.
 
  • #16
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I don't understand. If the study of macroeconomics is based on data provided by trends in behavior of everyone. It is first a study of microeconomics, and macroeconomics it is just a study of everyone's individual behavior all pooled together. My answer could have been better, yes, but if you do all those searches you will see how everyone has behaved in the past.
It is also not general phenomena, all those things I mentioned directly relate to the interest rate. They all relate to each other. So let me try again.
It's not sufficient to say that macroeconomics is built on the foundation of microeconomics. You need to be able to directly account for interactions between the two levels. Otherwise it would be like making claims about weather patterns and saying that they are grounded in the molecular behavior of water without actually being able to describe the relation between the two. If you're claiming that flooding is being caused by dams preventing water from flowing to the ocean, you need to be able to address the mechanics of HOW the dams increase rainfall, etc. Otherwise there's no way to critically discuss your claims because all you're doing is insisting that fractional reserve banking is the culprit without saying how or looking at other factors involved and the range of consequences for different situations.
 

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