Australian labour market data – mostly discouraging

This Post Has 164 Comments

1. I can’t wait for the old conservatives that govern the economy/labour market to retire and then us young people can rule the place. That’s what I always say to my boss at work, which could soon mean a further increase the unemployment rate.

   cheers

2. Dear Bill,
   I’ve just started reading your blog having recently got into monetary economics after encountering ‘the Ecology of Money’ by Richard Douthwaite, ‘the Grip of Death’ by Michael Rowbotham, and ‘New Paradigm in Macroeconomics’ by Richard Werner. Some of your own books are on order. I was heartened that you also take an interest in climate change and permaculture, topics that really motivate (and concern) me. I was wondering how you square the following circle. Judging by the blog, your basic normative economic perspective is growth oriented, to maintain full employment. But economic growth, particularly within the developed world, is the main driver of climate change. What would the implications be for MMT of non-growth economics and can this be squared with full employment? Or do we need to abandon full employment, if we think (as I’m inclined to) that saving the planet is more important? I would love to hear your views on these issues, which to me are where the real frontier social and economic issues are currently at.
   Best Wishes,
   Nick

3. NickB, good questions. They are questions I encounter regarding MMT also, which some progressives see as just another way of continuing business as usual.

   MMT just describes the modern (post ’71) monetary system and explains how it works. This suggests principles of monetary and fiscal policy along the ones of Abba Lerner’s functional finance. It also provides a version of macro based on sectoral balances, as developed by Wynne Godley.

   This view then has to be applied to specific data and particular circumstances to be useful. One on hand, it provides an understanding of current conditions, and on the other, shows what the different policy options are. Choice among options is a political matter, hopefully to be decided democratically after informed debate and due deliberation.

   MMT just deals with what is possible given the data. Why is this such an advance over the present mainstream approach. The present approach is theoretical, based on assumptions that are not empirically grounded and often just implausible if not already disconfirmed. MMT is non-ideological, and it can be applied in a variety of ways, across the political spectrum.

   Moreover, in approaching problem-solving at the global, international, and national levels, everything relevant has to be taken into account, not just economic “efficiency” in producing unlimited growth. It is obvious that unlimited growth is unsustainable with limited resources. The challenge facing humanity is to optimize resource use for general welfare and prosperity. This is going to involve conservation, technological innovation, and what R. Buckminster Fuller called “design science,” as doing more with less, e.g., by removing dead weight. This is as much an engineering problem as an economic one.

   Moreover, moral and ethical issues are involved, so it is at bottom not just facts but also norms that are at issue. Without acknowledging the genuine philosophical issues, the debate revolves around arguments over subsidiary issues like efficiency. Political differences are philosophical ones, although they are often disguised as economic ones. In general, MMT’ers generally take the philosophical position that government is about providing for public purpose, rather than merely providing personal security and protecting property rights. This does not imply that MMT’ers are “socialists,” however.

   Many MMT’ers are libertarians of the left without being social anarchists. They agree that while democracy may be flawed in many ways as it is practiced, it is the best system yet devised. They also agree that markets are the optimal means for price discovery. So MMT should not viewed as any kind of proposal for government takeover. They are aware that democratic government is susceptible to capture from the right and left, and many see present governments as being largely captured intellectually by the right at present. Since this is generally the direction “pro-growth” comes from, I would say that most MMT’ers are opposed to that in its present form, which clearly is not working.

   MMT provides a solid financial and economic understanding for approaching this challenge based on how the system presently works, how it might be changed to improve it, and what the options are for dealing with present challenges. One of the greatest “obstacles” is thought to be insufficient funds. MMT shows that this is not the real problem. Economics always comes down to real resources and their distribution. Money just facilitates transactions as a medium of exchange, provides pricing or resources and accounting records (unit of account), and stores value, allowing for saving as deferred consumption, as well as debt financing that draws demand forward. Money just “greases the wheels” of commerce, and the issuer must ensure that just right amount of grease is provided to reduce friction to prevent seizing up (deflation) without gumming up the works (inflation).

   So MMT per se says nothing a priori about conditions, e.g. through assumptions. It provides a lens for viewing data a posteriori, and a matrix (sectoral balances) for organizing it and extrapolating from it. This suggests possible options for fiscal and monetary policy, as well as dealing with money creation by banking as a public/private partnership, e.g., in light of Hyman Minsky’s financial instability hypothesis and Irving Fisher’s debt deflation theory of depressions.

   It is quite clear at this point in time that present conditions require a sustainable approach. MMT offers a reality-based framework for approaching that challenge in contrast to an ideological one that is based on myths.

4. “This does not imply that MMT’ers are “socialists,” however.”

   – so what do you call the objective of minimizing rentier incomes?

   “So MMT should not viewed as any kind of proposal for government takeover.”

   – thats exactly what “no bonds” is

5. Socialism is amorphous, but generally refers to government ownership of heavy industry and social guarantees. Setting interbank rates to zero will not accomplish this, neither will it reduce rentier income, even though the latter is also poorly defined.

6. “neither will it reduce rentier income”

   what are you talking about?

   of course it will

7. no bonds forces the banks to hold all government liabilities, except circulating currency

   that’s socialism

   and MMT’ers themselves admit that the objective is to minimize rentier income

8. Well, Banks are free to lend and hold those loans as assets. That is what they are supposed to do anyways. And not too many of them will complain at having low funding costs.

   Moreover, there is no correlation between call money rates and capital’s share of income. The latter has been roughly constant. If anything, capital markets cheer when there is a rate cut, as the real rentier income is driven by borrowing — really dissaving. It is the flow of dissaving that generates rentier incomes, not how that dissaving is financed.

9. I guess all of this depends on your definitions. If you define rentier income solely as income received from holding government bonds, then by definition not selling those bonds will reduce that income. But that is a meaningless definition in terms of social welfare.

   If you define rentier income as income received from non-wage sources — i.e. from ownership of the means of production — then capital’s share of income will remain at 35% whether the government sells bonds or not. It may shift from short term to long term bonds, or from bonds to equity, but someone holding a broad portfolio of assets wont notice the difference.

10. Anon: You need to define what you call socialism. Reducing rentiers’ income isn’t it. Paying taxes reduces rentiers’ income, so that doesn’t do it unless you think taxes are the same as socialism. Similarly, I don’t understand why you say forcing banks to hold excess reserves at a low or zero interest rate is ”a government takeover”. It’ll reduce bank profits somewhat but again so will taxes. Granted it reduces the portfolio choice for bonds of rentiers, but I don’t see how that’s a government takeover or socialism. I think ownership and control of capital and issues of distribution should figure in a definition.

    RSJ: Could you please explain the last sentence in your 6:39 post. Thanks.

11. Socialism is an economic and political theory based on public ownership or common ownership and cooperative management of the means of production and allocation of resources. As an economic system, socialism is an organization in which production is carried out by a public association of producers to directly maximize use-values, rather than exchange-values (see: commodity production), by rationalizing economic activity through conscious economic planning in investment decisions, distribution of surplus and in coordinating the use of the means of production. Specifically, socialism is a set of social and economic arrangements based on a post-monetary system of calculation, usually implying calculation based on some physical magnitude, such as labor time or energy units.

    http://en.wikipedia.org/wiki/Socialism

    Main Entry: so·cial·ism

    1 : any of various economic and political theories advocating collective or governmental ownership and administration of the means of production and distribution of goods
    2 a : a system of society or group living in which there is no private property b : a system or condition of society in which the means of production are owned and controlled by the state
    3 : a stage of society in Marxist theory transitional between capitalism and communism and distinguished by unequal distribution of goods and pay according to work done

    http://www.merriam-webster.com/dictionary/socialism

12. Keith,

    As I said before, this really depends on your definitions. Economists define rents as income greater than the marginal product. In that case, with monopolistic competition, there are always rents, but that definition is heavily dependent on whatever aggregation shortcuts you take.

    I would prefer do define a rentier as someone receiving income from ownership of financial claims. They may or may not also work. They may or not be wealthy. But this is a measurable definition that is independent of theory and addresses the issues that MMTers *mean* when they talk of rentier income — e.g. a decline in capital income that would result in an increase in the labor share of income.

    Now let’s look at households. During a given period, each household receives some income from financial assets and pays income from financial obligations. So each household has a net-income from the financial markets, which may be negative. Call this financial income. Those households with financial positive incomes are rentiers, and the sum total of this income is rentier income.

    Likewise, each household has a net income from the goods market (which includes proceeds of selling your labor) — and this may also be negative. Call this “goods income”.

    In all cases, we have, during a given period:

    sum of financial income + sum of goods income + sum of external financial income + sum of external goods income = 0.

    The sum is taken over all households. “external” refers to the the business, government and foreign sectors (all other sectors).

    Now collect all the household financial income terms that have a positive sign in them on one side of the equation, and move everything else to the other side:

    total rentier income = (total household net borrowing – sum of external financial income) – (sum of goods income + sum of external goods income)

    The first term here is total net dissaving of households plus the net dissaving of the foreign, business, and government sectors. We can call this “total dissaving”.

    The last term is just net exports, as all other terms cancel out. E.g. the labor income received by households cancels with the wages paid by firms, etc.

    So we have

    domestic household rentier income = total dissaving – net imports over period

    Therefore rentier income is determined by the sum total of net dissaving by each actor — other households, firms, and government, not by the specific instrument issued, or how that dissaving is financed.

    This is why the capital markets love rate cuts, and generally love low interest rates. To the degree that reduced borrowing costs encourage more borrowing, this increases rentier incomes. To the degree that high borrowing costs discourage borrowing (and they do, if they are high enough), this decreases rentier incomes.

    This is the exact opposite of the fallacious belief that high borrowing costs increase rentier incomes.

    The reason why the “micro” view is wrong at the macro-level is that the interest payments made subtract from spending elsewhere, and this lowers business revenue, which lowers dividend and interest income. That reduction in revenue is offset by an increase in revenue to the banks. So a hike in interest rates, holding the quantity borrowed fixed — merely shifts the income of rentiers so that they receive a little less from their ExxonMobil holdings and a little more from their MorganStanley holdings — the sources of incomes are shifted around a bit, but total rentier income is unchanged.

    All that really matters is the amount borrowed by others, not the terms of repayment. And this is why rentiers love rate cuts.

    And it is puzzling why a group of people that supposedly adhere to accounting identities continue to repeat this utter nonsense and about high interest rates promoting rentier incomes and low interest rates reducing rentier incomes. This is a classic fallacy of composition error, and all the big names on this board — you know who you are — should know better.

13. Trends In The Rentier Income Share In OECD Countries, 1960-2000

    There is no commonly accepted definition of rentier income. Most authors use a definition to capture income that accrues from financial market activity and the ownership of financial assets rather than activity in the “real” sector or the holding of “real” assets such as real estate or capital equipment. Lenin, for example, defines a rentier as “a person who lives by ‘clipping coupons’, who take no part in any enterprise whatever, whose profession is idleness”.3 According to The Penguin Dictionary of Economics, a rentier is “someone who receives his income in the form of interest and dividends rather than in wages or salary and who does not otherwise participate in the process of production. A provider of capital and person of independent means.” The Dictionary of Business: Oxford University Press defines a rentier as “a person who lives on income from rents or on receiving rent from land. The meaning is sometimes extended to include anyone who lives on the income derived from his assets rather than a wage or salary.”4 Keynes, in his General Theory, refers to the rentier as “the functionless investor,” who generates income via his ownership of capital, thus exploiting its “scarcity-value”.5 For this paper, we define rentier income similar to way the Michel Kalecki defined it in his famous article, the “Political Aspects of Full Employment” (Kalecki, 1972). For Kalecki, rentier income referred to incomes accruing to those owning financial institutions and financial assets more generally.

14. “And it is puzzling why a group of people that supposedly adhere to accounting identities continue to repeat this utter nonsense”

    It is impossible to even begin to describe how confused you are on this. You are lost in “net financial asset land”.

    The relationship between the level of interest rates and the share of interest income in national income is very evident from the structure of the national accounts.

15. Anon, there was absolutely nothing coherent in your post *except* the easily refuted statement about national accounts. It is not just interest payments, but all returns to capital that you need to measure — that includes dividends as well as proprietor income. The national income identities refute your claim, as does tax data. Saez has done good work on this as well. The rest of your comment about NFA was just babbling — I wasn’t talking about NFA at all, but about rentier income.

16. Oops — wrong link. I gave the link to rentier income as measured by the CBO from tax data. this is the link for dividend + interest income + proprietor income from the national accounts. It remains constant even though rates have changed greatly over the same period.

17. That’s an interesting study, Tom. It seems that they define rentiers as only bondholders plus all corporate profits in the financial sector, which is why their curves deviate from the capital’s share of income curves. But even then, the curves are not correlated with interest rates, but tend to rise even as rates fell. In all of these discussions, you need to define what you mean by rentier up front, otherwise there wont be any progress made. For some reason, holders of equity are ignored on this board, even though in reality everyone receives capital income from a blend of equity and bonds, and equity income is roughly double bond income. And then you have convertibles, preferred shares, and other more exotic instruments.

18. Anon,

    “so what do you call the objective of minimizing rentier incomes?”

    Georgism. Rents are not “profits” nor “wages”, in the classical sense of the term. On this view, MMT has much in common with Ricardo, JS Mill, Adam Smith etc. (whoa, all those socialist right there!), You will notice “rentier” incomes (particularly, in real estate markets) precede all major downturns – panic of 1819, 37, 57, 73, 93, 1907, 29, 55, 75, 90, 2007 – as resources for output and investment (i.e. production) are allocated to rent-seeking activities.

    Reducing rentier incomes? You say that as if its a bad thing.

    “thats exactly what no bonds is”

    MMT teaches us that tax revenues are obselete (so perhaps it has a libertarian streak to it, as Ruml realised?); anyways, it also teaches us (1) the private sector loves a safe asset (so the “market” is really irrelevant when it comes to bonds in a fiat currency system – the private sector loves bonds as an asset – just ask Japan) and (2) with bonds government merely recoups what it has already spent prior to issuing the bonds. That is how our monetary system works.

    And just using ad hominem words like “socialism”, “government takeover” etc is no substitute to reasoned, empirically-informed discussion.

    Your two premises are dismissed.

19. From your own source:

    “The United States displays a dramatic increase in the years prior to 1989, a peak in 1989, and an equally
    dramatic decline after the peak year. By the late 1990’s, rentier income share in the United States had
    declined to the level it had been in the mid-1970’s. Other countries that display this trend are Australia
    (peak = 1989), Norway (1990), Finland (1992), Canada (1990), Portugal (1991), Spain (1993), and
    Greece (1991). The increases and declines of rentier income share in these countries are dramatic.”

    Could the relationship with interest rates be any more obvious?

    “No bonds” assumes zero interest rates – there’s no point in no bonds otherwise.

    A permanently zero risk free rate means all returns to capital are minimized. That’s socialism.

20. “Therefore rentier income is determined by the sum total of net dissaving by each actor – other households, firms, and government, not by the specific instrument issued, or how that dissaving is financed.”

    This is drivel.

    Net income on financial assets is easily derived from the national accounts.

21. Anon: A permanently zero risk free rate means all returns to capital are minimized. That’s socialism.

    That’s your own definition of socialism. See standard defs above.

    If we aren’t going to use words in their accepted meaning, I’m not sure how an objective debate can be conducted. If you want to call in something like “Anon’s concept of socialism,” I’m OK with that. After all Glen Beck and Sarah Palin have their own concepts of socialism,” etc., and I guess they are entitled to their own views as long as they make their definitions clear and distinguish them from what the accepted definition is.

    The government taxing people, not issuing bonds, etc. is NOT the accepted meaning of “socialism,” no matter what Libertarians believe the English language means. (I am not saying you are a Libertarian). I’m pointing out that there is no communication across the an existing divide because the parties are not speaking the same language.

22. “If we aren’t going to use words in their accepted meaning”

    It’s not my definition; nor is it my concept.

    It’s descriptive of a policy that has a socialist orientation.

    If you disagree, how else would you characterize a policy that is consistent with:

    “A permanently zero risk free rate means all returns to capital are minimized.”

    The replacement tax effect is unknown. But the interest rate policy crushes existing returns to those who save in the form of financial assets – not only existing returns on government bonds, but the risk free component of non government returns (before the addition of the risk premium), as well as the risk free component of equity returns (before the addition of the risk premium).

    It’s a fundamental reduction in the return to capital.

    How else would you characterize it?

23. I think the question should be phrased as: “Since the yield curve is exogenous or can be made exogenous, what should the central bank do ? ”

    The Taylor rule that it follows is based on the NAIRU myth.

    This paper by Louis-Philippe Rochon looks interesting to me Interest rates, income distribution, and monetary policy dominance: Post Keynesians and the “fair rate” of interest. I have a copy, though I wish copyrights would allow me to share it.

    I liked RSJ’s point that the phrase “rentier” is not well defined. I wish I knew more about the phrase to participate in this interesting discussion.

    I like the rule of setting the overnight rates to zero, though I want to get involved in a debate/discussion about it. RSJ has some points about equity price bubbles and I also may have some thoughts like that but with a different view. I also would like to discuss the implementation of the rule because I think the issue of collateral is important.

    The banks’ balance sheet in the Kansas CoFFEE rule is simplified to

    Assets – Reserves, Loans, Real Assets
    Liabilities – Deposits, Funds owed to the central bank.

    There is no securitization, and no government bonds, and no collateral for central bank advances.

24. ‘rentier’ is a dumb, old fashioned word that economists like to use

    what we’re talking about basically is return on financial assets

    that’s consistent with Keynes and Kalecki

    the existing system has dual monetary and fiscal policy

    MMT wants to eliminate existing monetary policy from the mix

    it does that by eliminating discretionary interest rate targeting

    it sets rates at zero and leaves the rest up to taxes

    and it eliminates bonds

    the effect of eliminating bonds is to eliminate market pricing for expected monetary policy

    since there is no risk under expected monetary policy under MMT, this is a justification for eliminating bonds

    the entire proposal strips out a positive risk free rate and a term structure for the risk free rate from the pricing of all risk assets (risk free return plus risk premium = 0 + risk premium)

    the full effect is to compress returns on capital as much as possible – that hurts people who save in the form of financial assets, and MMT doesn’t give a damn about it – in fact it embraces that objective

    the idea is to squeeze returns to capital and transfer the difference over to labour

25. “the idea is to squeeze returns to capital and transfer the difference over to labour”

    Maybe.

    It seems you have a problem with actually paying people who work instead of letting people who think the world cant run without “their” money call all the shots.

26. “It seems you have a problem …”

    I have a problem with the policy objective of stripping income from people who’ve saved.

27. Anon,

    “I have a problem with the policy objective of stripping income from people who’ve saved.”

    The reply would be: people are free to invest in other securities such as corporate debt and equities. Now one can argue that if overnight rates are brought down to zero other interest rates will also be less. The counter argument may be that low interest rates are good for employment. Of course the no bonds proposal goes along with the JG program proposal as well, but there is a hierarchy in the society and not everyone would be willing to work at the wage level set and hence the government needs to be good to people who are not in the low end in the wage spectrum.

    Just some thoughts. Not arguing one way or the other.

28. Anon,

    Further the argument you may be confronted with is – the savers don’t really fund anything, its investment which leads to saving etc. So its not that the savers are really helping the production process. Etc.

29. the idea is to squeeze returns to capital and transfer the difference over to labour

    Brilliant deduction, but not stated quite correctly, I would argue.

    The term “capital” has several meanings:

    1. Cash or goods used to generate income either by investing in a business or a different income property.
    2. The net worth of a business; that is, the amount by which its assets exceed its liabilities.
    3. The money, property, and other valuables which collectively represent the wealth of an individual or business.

    Investopedia

    The first meaning is the economically precise meaning, e.g., as in Y=C+I+(X-M). “Investment” means expenditure on capital goods.

    Return on capital is “a measure of how effectively a company uses the money (borrowed or owned) invested in its operations. Return on Invested Capital is equal to the following: net operating income after taxes / [total assets minus cash and investments (except in strategic alliances) minus non-interest-bearing liabilities]. If the Return on Invested Capital of a company exceeds its WACC, then the company created value. If the Return on Invested Capital is less than the WACC (weighted average cost of capital), then the company destroyed value.” (Investopedia).

    Return on capital is profit resulting from production, just as wages are the fruit of productive labor.

    The trading of finance assets is properly called speculation rather than investment, since it is not directly related to production. Therefore, this is “unproductive” and if excessive becomes parasitical by diverting funds from productive investment and compensation for production into non-productive channels.

    So this is not “socialism” either, because it leaves the means of production in the hands of capitalists, i.e., those who take real risk through investment in production, rather than financial risk through speculation. This, as I understand it, is more or less what Keynes meant (although I may not have stated it well).

    Regarding no bonds and interest rates. I have two reasons for wishing to see the US government cease debt issuance. First, under a fiat system it is unnecessary and Ockham’s razor should therefore be applied for efficiency. Secondly, the use of bonds in a fiat system is for convenience of the CB in setting monetary policy, which boils down to managing in interests rates. Investing a small unelected and unaccountable group of technocrats control over setting the price of money for an entire society is anti-democratic and anti-capitalist. I offer Hayek’s eloquent, The Use of Knowledge in Society, in defense of this assertion. Moreover, the Fed in non-compliance with its dual mandate to maximize price stability and employment by using interest rates in setting to target inflation, with unemployment as a trade-off.

    It can also be argued that fund parked in risk-free government provided securities with the reward of interest not based on risk diverts funds from other uses, in particular productive investment. As a result, it results in a subsidy, which is a dead weight.

    At least, that’s the way it appears to me.

30. There is a rule called Fair Rate Rule according to which the real rate of interest should be equal to the trend rate of growth of labor productivity. With such a rule, if I save an amount equal to one hour of work, I can obtain a purchasing power equal to one hour of work in the future. So in some sense “fair” for the savers.

31. “Further the argument you may be confronted with is – the savers don’t really fund anything, its investment which leads to saving etc. So its not that the savers are really helping the production process. Etc.”

    That’s a very dangerous and erroneous argument.

    Saving is forced at the macro level but elective at the micro level. To the extent there is product of some sort on the shelves, nobody at the micro level is forced to save.

    Those who have elected to save have their own claim on macro saving, macro financial assets, and macro investment.

    You might call the argument in question the fallacy of decomposition.

32. anon: There is a big difference between the ability to save from income, which implies an adequate income to do so, and the ability to save from savings. The easier the prior is, the less need there is for the latter. What is it you don’t like about that? I agree that there should be a possibility for individuals (not corporations) to hold risk free assets to a certain extent and earn income on them in line with overall growth (which they after all helped support with work). And most MMTers would support a guaranteed claim on real real services for the aged and ill in exchange for portion of income, depending on the state of the economy. That is also akin to saving, and has the benefit that it leaves no room for corporations to ‘invest’ those savings in claims on the very produce the people are producing. I think the big issue is the illusion that capitalism as we know it constitutes some sort of meritocracy. Arguing that if one manages to play the system one will be awarded by it, is tautological. Tell me who deserves how much of what we make and why.

33. “There is a big difference between the ability to save from income, which implies an adequate income to do so, and the ability to save from savings.”

    I can’t address the rest because I don’t understand that.

    It sounds like you’re opposed to compound interest.

34. “The term “capital” has several meanings”

    I was using the term loosely in the sense of financial assets. I recognize it departs from normal use in economics, but it is common to use it that way in financial markets.

    You have to be quite careful with that WACC reference/application. What it really means is that ROC WACC. That has to do with the stability of the market value capitalization of book value. In fact, ROC<WACC is still quite consistent with increasing book value, which reflects normal value creation through income.

35. “The trading of finance assets is properly called speculation rather than investment, since it is not directly related to production. Therefore, this is “unproductive” and if excessive becomes parasitical by diverting funds from productive investment and compensation for production into non-productive channels.”

    Without questioning the blanket of “speculation”, I do question the funds “diversion” meme. Economists should be more circumspect about this. Trading existing financial assets is a zero sum game. It’s pervasive and has to do with personal freedom to manage one’s financial asset portfolio.

    Productive investment usually requires new financial asset creation. It’s not clear to me that the acceleration in trading of existing assets has prevented investment and new financial asset creation. To some extent, its comparing apples and oranges.

36. Look, this is simple. I am defining rentier income to be capital income. Capital income — according to NIPA as well as tax records — has stayed roughly constant in the U.S. In other nations, it has risen somewhat. All this time, rates have been first rising until 1980 and then falling to zero. Therefore you cannot argue that capital income will decline (and therefore labor shares will increase) if the call money rate is set to zero.

    Regarding the study Tom cited, they show capital income rising from 1980 to 1989, when rates were falling. Over that period, a negative correlation. Over the longer period, a positive correlation. Why? Because the authors define rentier income to be only bond income, but not dividends — except for the financial sector. All financial sector profits are rentier incomes to the authors. In that case, the global housing crisis/bank crisis in the late 80s/early 90s led their definition of rentier income to decline.

    Regardless of whether the government sells bonds or not, the private sector will sell both bonds and equity, and having low overnight interbank rates is not going to drive the risk-adjusted returns to zero. Bank lending is marginal to these markets. What is important is the cost of equity. A business has the option of raising funds from bonds or from equity — either selling more equity or paying fewer dividends. The bulk of investment is from equity, not bonds, and the bulk of capital income arises from ownership claims rather than rental claims. When talking about rentiers, Kalecki was referring to both — both the receivers of business profits ex-interest as well as the receivers of interest payments.

    In reality, it is the same group of people. The discount rate is determined from the equity costs, because that is the trade-off that the borrower — the owner — faces. The business is not able to obtain funds from a bank, as bank loans cannot replace credit market instruments.

    And we can see this at work historically.

    During the post-war period, bond yields were low across the board — there was an enormous fear of risk — and as a result, businesses were able to lever up, obtaining funding that was (ex-post) too cheap from debt and therefore supplying (ex-post) excessive dividends. The result was a historic equity boom that burst in 1966. Funds were transferred from rentier interest income into their dividend income. But the total rentier income did not decrease.

    During the 80s, bond yields were (ex-post) too high and as a result dividend income was suppressed and interest income rose. Note that I am talking about the income flows here, not the yields. In both cases, total rentier income remained constant.

    In all cases, having low overnight rates may or may not encourage excess real estate borrowing, which may or may not boost capital income. It will certainly not decrease capital income, neither will the lack of bonds suddenly allow capital returns to fall to zero. Capital returns will remain set by opportunity cost, and over long run time periods, they will be equal to the growth rate of the economy — assuming that the growth rate of the capital stock increases with the same rate as the economy as a whole.

37. “First, under a fiat system it is unnecessary and Ockham’s razor should therefore be applied for efficiency. Secondly, the use of bonds in a fiat system is for convenience of the CB in setting monetary policy, which boils down to managing in interests rates.”

    The first depends on whether you eliminate monetary policy with zero rates. If you do that, then agreed you may as well do away with bonds for efficiency. But you don’t do the first without the second.

38. the risk free rate is an embedded component of both bond and stock returns

    you can’t argue that one offsets the other when the risk free rate is being stripped (set to zero) for both

39. Ramanan

    There is a rule called Fair Rate Rule according to which the real rate of interest should be equal to the trend rate of growth of labor productivity. With such a rule, if I save an amount equal to one hour of work, I can obtain a purchasing power equal to one hour of work in the future. So in some sense “fair” for the savers.

    Unfortunately interest rates are not set by a sense of fairness — which is great, because judging fairness is subjective — but because of arbitrage. A business can either borrow from the bond markets or it can retain earnings (borrowing from equity). When yields fall (and capital gets too expensive) — we can make more! There is not a fixed supply. So the cost of capital (which is the return on capital) is not set by the financial system, but by the real economy. How much of that return is captured by the financial sector, as opposed to other sectors is set by regulation. Lowering funding costs for the financial sector is not going to drive capital returns down, but it may drive the financial sector’s capture rate up. Whether it does or not depends on the associated bank regulation. The proposals here are to forbid banks from holding any asset other than bank loans that they hold to term. In that case, the remaining risk is one of real estate bubbles, since that is what banks lend against. If, in addition to that you prevent banks from enabling real estate bubbles, then the remaining risk is that they will earn excess returns. If in addition you tax them heavily to ensure that their profits are in line with the non-financial sector (and you need to prevent them from earning labor rents as well), then the zero interbank rates wont affect the economy at all. Everything will go on as usual, except that the short term rates will be a little lower and long term rates will be a little higher — the yield curve will be steeper, but again you will be taxing the hell out of banks to prevent them from earning an excess profit from this.

40. The first depends on whether you eliminate monetary policy with zero rates. If you do that, then agreed you may as well do away with bonds for efficiency. But you don’t do the first without the second.

    Yes, that is what I am proposing. As I see it, they go hand in hand.

    I would also separate retail banking from finance other than homeowner mortgages. I think that government should be involved in retail banking to the extent necessary, but it should stay out of finance other than as referee to ensure no cheating and no usury.

    It has also become clear that government has to be involved in reducing/eliminating systemic risk. This should be done insofar as possible by changing incentives but regulation, including anti-trust legislation, will likely be required, too. Too big to fail creates an implicit subsidy/dead weight that distorts the mechanism of risk, which is at the heart of free market capitalism.

41. To “strip” credit risk, you look at returns ex-post. Ex-post, or risk-adjusted returns, average out to the risk-free returns. Having no risk-free bonds does not mean that the risk-adjusted return goes to zero. Just because you are getting rid of a tool to measure the risk-adjusted returns does not mean that the risk-adjusted returns go away.

    Just because the yields from equity and bonds can be measured as a credit-risk premium over long term government bond yields does not mean that if that measurement tool is removed, that there will be zero risk-adjusted return. That is a massive confabulation. The risk-adjusted return, or the ex-post return will continue to average out to be the growth rate of the economy.

42. sorry, i’m neither a native speaker nor an economist. i’ll try to keep it simpler in future. one more attempt to clarify: first, there is no way to asses a ‘just’ distribution between wages and returns on capital. every system will produce its own outcome and inequalities (moral ineptitudes), which over time will compound and thus be exacerbated. any attempts to counter these inherent systemic failures without introducing a new system will incorporate redistribution of some sort, but that doesn’t make it socialism.
    about bonds: it seems to me that they are claims on labour output with a guaranteed return on investment but with nothing to back them to merit the term investment. so while i find those who have contributed to output may be given a limited privilege of profiting from such an asset as a distributive gesture (from who to whom, i wonder?), there is nothing in my mind that would merit such an opportunity for all.

43. Oliver, there is absolutely nothing *guaranteed* about bonds. Only government bonds are guaranteed, and what is confusing the hell out of everyone on this board is the fact that in a growing economy, there will always be a positive risk-adjusted return.

    If there were no government bonds sold, any investor could still purchase a broad basket of bonds (and stocks), and those assets would only simultaneously default if the entire economy collapsed to zero, in which case his government bond holdings would not help him.

    The purchaser of the broad basket of risky instruments gets the same return as the purchaser of risk-free instruments, at least over long time periods. And it just bothers people to no end that there is a positive risk-free return — they are absolutely convinced that someone is getting something for nothing. But the “cost” of that return is just the opportunity cost of investing in a growing economy. Wages will grow, capital will grow, productivity will grow — everything is growing! And so the assets will also grow, and the growth rate of the assets is equal to the yield.

44. 4:55

    why don’t you read the earlier comments instead of making it up

45. Anon, you argue that just because no government bonds are sold, that suddenly the risk-free rate must be zero.

    I am arguing that the risk-free rate is just a proxy for the risk-adjusted rate. Due to arbitrage. The risk-free bond yields tell us what the expected risk-adjusted yields are, modulo all the government interventions that add noise to this data.

    But you are confusing a way of measuring perceptions of the the ex-post return with a way of controlling the ex-post returns. The ex-post returns — which are the returns after risk is removed — will continue to be positive, and they will continue to be the growth rate of the economy.

46. “Anon, you argue that just because no government bonds are sold, that suddenly the risk-free rate must be zero.”

    No I did not.

    Read the comments.

47. RSJ @ 4:47,

    I was actually talking of a rule to set the interest rates not about the behavior at present. There are so many interest rates and the question is “which interest rate”. I haven’t gone through seen this part in the PKE literature, though in general I find their work very satisfying. I do not know the answer at present but I believe one can achieve something like that. It could involve some payment from the government to household accounts by directly crediting their bank deposit accounts. (just guessing). The other interest rates or yields can do whatever they want because households volitionally bought those securities.

    The important question to debate is what should be the monetary policy? The present central bank reaction function is something which is based on incorrect economic reasoning.

48. There are so many interest rates and the question is “which interest rate”.

    For each maturity, there can only be one risk-adjusted rate, which is also the risk-free rate. There cannot be two. Otherwise, what lender would lend at the lower rate instead of the higher rate?

49. rsj. thanks for clarifying. i think i see what you’re getting at (slowly, very slowly). btw. i was always talking about government, not corporate bonds. re rate of return: maybe a question for to help me understand: why aren’t wages paid in something equal to government bonds that guarantee the same return? why the two-tiered system?

50. If you’re still trying to figure it out, I said the elimination of monetary policy (zero rates) was the justification for the elimination of bonds. Bonds yields are the market’s view on expected monetary policy and the risk around expected monetary policy. When the risk of monetary policy is removed (rates permanently fixed at zero), there is no reason to have bonds. That doesn’t mean you can’t eliminate bonds while maintaining non-zero rates. But that’s a weaker case for MMT. The preferred MMT proposal is eliminating both.

    But this is complete nonsense:

    “I am arguing that the risk-free rate is just a proxy for the risk-adjusted rate. Due to arbitrage. The risk-free bond yields tell us what the expected risk-adjusted yields are, modulo all the government interventions that add noise to this data.”

    I can’t imagine what you’re trying to say here.

51. Anon @3:58

    agreed!

52. Anon, the government will only stop selling government bonds. The private sector will continue to sell bonds, which have a positive risk-adjusted return. For a specific bond, you will still decompose the interest rate into a credit-risk term and a risk-free term, and the risk-free term will remain non-zero, even though there are no government bonds. It will just make the pricing of the private sector bond a little more difficult.

    If you don’t understand why the risk-free rates are the same (on average) as the any other ex-post return, then I can’t help you.

53. “Anon, you argue that just because no government bonds are sold, that suddenly the risk-free rate must be zero.”

    No I did not.

    Read the comments.

    anon@ 2:01

    “the entire proposal strips out a positive risk free rate and a term structure for the risk free rate from the pricing of all risk assets (risk free return plus risk premium = 0 + risk premium)”

    Here, you are arguing that the government is able to set the risk-free return to zero. I am arguing that the risk-free return is nothing more than the risk-adjusted return, on average, and that this will not be zero. This seems to confuse you. I can’t help you with that. The term structure will remain there, and it will remain positive. It will be more difficult to measure because you can’t determine it from looking up government bond yields, but nevertheless for all bonds

    rate charged = risk-free rate + risk-premium = anticipated risk-adjusted return + risk-premium, and both terms will remain non-zero regardless of what the government does with fedfunds or bond sales — at least for the longer end of the curve.

54. Anon,

    I guess what RSJ is trying to say is that if we don’t have government bonds, the yield for one particular maturity does not imply the default rate. For example if the one year rate on a corporate paper is 2%, (in the absence of T-bills), it doesn’t necessarily translate into a 2% probability of default. At a more technical level, the instantaneous forward curve is not the hazard rate curve if government yields is zero.

55. “Anon, the government will only stop selling government bonds. The private sector will continue to sell bonds, ”

    Good grief!

    I know that.

56. “This seems to confuse you.”

    It is you who are confused, and not for the first time.

    In the scenario, the government sets the risk free rate at zero, by policy.

    If the policy rate is set at zero permanently, and if the market believes the commitment of the policy, then the forward rates for the risk free rate are zero, and the implied risk free yield curve embedded in risky bonds is zero. Risky bond yields consist of the risk premium only, unlike today, where they = non-0 risk free rate + risk premium.

57. you are completely confusing risk adjusted return with risk free rate

58. Oliver,

    Wages are income, and all income is paid in cash, whether that be dividend income or wages. What you do with that income is a separate question.

59. you are completely confusing risk adjusted return with risk free rate

    In arbitrage-free markets, the two are the same. Really I don’t have time to teach you these things, and you shouldn’t be commenting on here if you don’t know the basics.

    Of course in the “real” world, the returns are not known, but there is no reason to believe that one is always higher than the other. On average, these errors will cancel out.

60. Given your persistent bluffing and BS about basic finance matters, your own comments here are a public disservice.

    Risk adjusted return and risk free rate are completely independent – but very consistent with my earlier comments about MMT risk free stripping:

    ————————————————————————————————————————–
    To calculate risk-adjusted return, subtract the risk-free rate from the investment’s return, then divide the resulting number by the standard deviation of the investment’s return. The value of a risk-adjusted return lies in its ability to reveal whether an investment’s returns are attributable to smart investing or excessive risk-taking. Risk-adjusted return is a useful tool for factoring volatility into investment decisions.

61. I’ll bet Bill Mitchell knows the (fundamental) difference between the risk free rate and risk adjusted return.

62. Anon, you are defining the Sharpe ratio, which is the financial industry benchmark for measuring alpha.

    But in an arbitrage-free market, alpha is going to be zero, which means that the mean return (or the expected return) is going to be equal to the risk-free rate. I.e. the return ex-post will be equal to the risk-free return.

    Therefore the problem with using the sharpe ratio is that it assumes that investors are risk-averse and therefore they will always pay a premium for the risk-free asset, allowing for a positive alpha. But in actual markets you have risk-neutral arbitrageurs that negate the preferences of households, and drive alpha to zero.

    This is in general a problem with theories of asset demand — they are not arbitrage-free theories if you reject loanable funds and simultaneously allow for risk-neutral investors. If you reject loanable funds, as I do, then the sharpe ratio (and other measures of alpha) will be zero, and as a result, the only way of measuring risk-adjusted return to take the expected return, or the return ex-post. This will be the risk-free rate. And this fits well with historical data over long time periods.

63. oh, so now its mean return, or expected return, to finesse the explanation

    bluff and switch

    bluff and switch

    you never stop

    here and on the other blogs

64. And in terms of what Bill believes, you check — he recently did a blog post about Australian super-annuation funds, outlining how their return was not in excess of the risk-free return. The australian economy, as with any other modern economy, grows at roughly the long term risk-free rate, and this is also the ex-post return that you can expect to get, CAPM scams notwithstanding.

65. Oh, I don’t know, Anon:

    First, it was that capital returns are positively correlated with the interest rate — according to NIPA. I disproved that — using NIPA — and was met with silence. Next, you argued that not selling bonds would strip out the risk-free rates, and I called you on it. You said you said no such thing, and I provided the quote. More silence. I’ll let the readers decide about bluff and bluster.

    The fact is, returns to capital — which is the Kaleckian definition of rentier’s income, and the definition that I was up-front about using — do not depend on the interest rate. There is overwhelming evidence for this. Next, although the government can certainly supply arbitrage profits to the financial sector by steepening the yield curve, such an action is not going to drive the risk-free rates to zero, nor will it alter long run yields. I think I provided a pretty good case for this, but all you provided was ridicule, and frankly — a lack of understanding. Bluff and bluster indeed.

66. anon, I’ll bet you have no clue (fundamental or otherwise) about socialism. So you are not qualified to make a judgement about existence or not of rentier income under socialism. Therefore your initial argument (whatever it was) is wrong.

    And please stop making an elephant out of a fly once again. It is unconstructive and getting annoying.

67. Dear anon, Sergei, RSJ and all

    Remember on this blog, we aim to argue and debate vigorously but also to keep it amicable. That requires calm tempers and a due regard and respect for each other!

    I am thinking about all the comments and when I get some time I will give some views.

    best wishes
    bill

68. one final note:

    you can search the finance literature until the cows come home and you won’t find an equivalence between the risk free rate and risk adjusted return

    that’s because risk adjusted return always nets out the risk free rate, whatever definition you use

    I responded sufficiently to your other claims, given their fragile quality

    Sergei – i never claimed to define socialism; i said that minimization of returns to capital was socialism (i.e. symptomatic thereof)

    Bill – nicely moderated

69. “he recently did a blog post about Australian super-annuation funds, outlining how their return was not in excess of the risk-free return’

    so what?

    that doesn’t mean the risk adjusted return = the risk free rate

    it means the ex post risk adjusted return is zero

    … and now for the switch

70. anon, capital does not formally exist in socialism as socialism by definition means socialized capital. So what is it exactly you are talking about when you say “minimization of returns to capital”?

    Seriously. People can and do save in socialism as well. Whether you call it government bonds or bank deposits is not a big difference because in socialism _all_ bank deposits are socialized in terms of risk. Elimination of government bonds still retains private yield curve due to time value of money/consumption even if in socialism this yield curve is controlled by the government. So banks will pay interest on essentially risk free (term) deposits which are substitutes for government bonds which would be no longer sold due to absence of monetary/interest rate policy.

    Next, though loans generate deposits banks still have to fund themselves one way or the other because of interbank settlement needs. These needs do not depend on political system, be it socialism or capitalism. The fact that this link (loan->deposit->settlement->funding) is often realized post factum does not change the conclusion that depositors participate in capital formation. In socialism this participation is credit risk free but it still pays income. This depositor income is indirect (in the sense that there is no direct financial transaction) rentier income and is part of interest rate that bank charges to _government_ owned / socialized enterprises.

    So there is rentier income in socialism even if it is socialism and it abandons monetary and interest rate policy.

71. Yes, Bill, I’ll for my part I’ll tone down the snark.

    For those wanting data, Saez has done good work tracking capital income in the U.S. Saez shows that factor shares in the corporate sector have been constant from 1929 until 2002 (figure VI of reference). In the personal sector, capital income has been rapidly rising from 10 to 20%, from 1944 to 2002 (also figure IV, referenced). As an aside, in the U.S. the real issue the distribution of the wage share (figure VIII, and also figure XI), rather than the total labor share of income.

    The earlier Congressional Budget Data I cited is can be found here. Again, you can compare capital income with historical interest rates to determine whether or not there is a correlation. The story remains the same — increases in interest income are weakly correlated with rising rates, but this correlation is more than offset by dividends and other forms of capital income, so that in aggregate labor’s share does not increase when the interest rate falls.

    As to whether the no bonds proposal is socialism or “strips out a positive risk free rate and a term structure for the risk free rate from the pricing of all risk assets (risk free return plus risk premium = 0 + risk premium)”, this really gets to the question of whether, in a growing economy, the interest rates charged purely reflect credit-risk or whether there is an expectation of return even after taking account of credit-risk. And more importantly, whether government can control this return expectation. And if it can control this return, will doing so just shift income into equity and away from bonds or will it really increase labor’s share of income? I think this is what is important in this discussion.

    Anon is right — I should not have said “risk-adjusted rate”, but “expected return”, or “ex-post return”. Mea culpa.

    The argument I was making is that although the risk-free rate currently serves as a convenient way to price risky assets, that even were the government to stop selling bonds or otherwise use monetary policy to set the interbank rates to zero, that bonds would not be priced according to “0 + credit risk”, but rather “expected return + default risk”. This is a tautology (e.g. credit risk = default risk, and the latter disappears in the expectation) — so it’s difficult to argue with this point. What Anon may dispute — I’m not sure — is whether expected return = risk-free rate. Those who believe that in an arbitrage-free market, alpha is driven to zero, will agree. Those who believe that with prudent portfolio management, alpha can be positive will disagree. It is my contention that alpha is zero over long time periods, and that the expected return over long time periods is determined by the economy, by things like technological change, and is not open to government control.

    Government, when it shortens the short end of the curve, is allowing for arbitrage — on the part of banks, and those arbitrage profits are channeled to bank shareholders and creditors — again rentier income is not reduced, and if anything is increased. Any attempts to give banks access to zero overnight rates should be combined with heavy taxation of bank profits to prevent them from earning returns in excess of the non-financial sector.

    The longer end of the curve is much more difficult to for the government to control, but again, any success in pushing those yields down will only result in re-routing income from one set of instruments to another — from bonds to equity or private equity.

    In the end, the labor share of income will not benefit from this.

    I think (in the U.S.) labor share of income is fine where it is now, and tax policy along with industrial relations policy is how you can improve the distribution of wage income. You can also use capital gains taxes to reduce capital’s share of income. This approach is better than a (futile) attempt to squeeze capital income by giving banks low funding costs. Higher funding costs would be better, as it would push down real estate prices and limit debt growth. In principle, none of this requires that the government does or does not sell bonds — lack of bond sales can be offset by additional asset fees placed on banks.

    Hopefully future conversations will have less animosity.

72. “Anon is right – I should not have said “risk-adjusted rate”, but “expected return”, or “ex-post return”. Mea culpa.”

    you see, the problem with this is that it completely changes the meaning of everything else written around it – that is, the coherence or incoherence of it according to the attentive and knowledgeable reader

    and once such a fundamental and incredibly obvious error has been made – one that is absolutely pivotal to the discussion – and one that is defended with utmost resistance – well, it calls into question everything else around it

    and the risk/return in even reading it

    and this isn’t the first time

73. “Hopefully future conversations will have less animosity”

    if you had started by apologizing directly, rather than whimpering to Bill, it might have assisted with this objective

    but I’ve seen your style too often now, so I know better

74. Bill,

    if you do take the time to review some of the thoughts in this particular blog conversation

    kindly take note that I’ve used the word “socialism” only a very small number of times

    on purpose

75. Anon,

    just to clarify,

    Are you still claiming that not selling bonds and setting the overnight rate to zero will result in “It’s a fundamental reduction in the return to capital.”?

    And that it is obvious, from the national accounts, that there is a positive correlation between rentier income as defined by you (“what we’re talking about basically is return on financial assets”) and FF?

    And that “If the policy rate is set at zero permanently, and if the market believes the commitment of the policy, then the forward rates for the risk free rate are zero, and the implied risk free yield curve embedded in risky bonds is zero. Risky bond yields consist of the risk premium only, unlike today, where they = non-0 risk free rate + risk premium.”

    To me — those are pretty glaring errors. And what’s more important, they have serious implications for what the best policy should be.

76. People living outside the US and unfamiliar with what passes for “the news” may not be familiar with what this kerfuffle over “socialism” is about. Currently, the GOP doing its best to paint Democrats as “socialists” and the president’s policies as promoting “socialism.” There is not even a hint of socialism in the US in the sense of state ownership of the means of production. Most Americans don’t have a clear ideal about what “socialism” means economically and politically, only that it was the basis for both Communism and Naziism (National Socialism). Therefore, “socialism” is a politically poisonous label in the US. Conservatives unabashedly make this connection, and the media just echos it.

    Conservatives connect socialism with statism. They draw a false either/or distinction between free market capitalism/democracy and socialism/statism, even though the US has a mixed economy. Conservatives in general believe that the New Deal brought socialism to the US, and they have been trying to escape it ever since. Thus, the movement to end all social welfare programs, even very popular ones like Social Security and Medicare (public social insurance programs that workers must buy into).

    Therefore, it seems important to distinguish between “socialism” and “socialization.” The US has virtually no public ownership of the means of production, temporary public ownership as collateral for bailouts notwithstanding. However, every government “socializes” resources for public purpose, if only to meet its overhead.

    Libertarians correctly recognize that government expenditure transfers real goods and services to public use. This involves socialization of those resources. Taxation also withdraws funds from non-government, and that can be seen as a form of socialization also. Arch-conservatives and Libertarians call for ending taxation. They make exceptions only for protection of persons and property, e.g., the military and other security forces, judicial system, prisons, and so forth.

    When one labels any socialization of resources “socialism,” then “socialism” loses its fundamental meaning and is divorced from all connection with socialist systems. To conflate these connotations is just a confusion, or else a disingenuous rhetorical device. This rhetoric, picked up by the media echo chamber, is a “hot potato” for the Democrats in the US right now, due to the intense barrage from the right. It is also being used to purge GOP officeholder and candidates of anyone who is not an arch-conservative or libertarian.

    The political basis for deficit terrorism is this distinction between free market capitalism/democracy/freedom and socialism/statism/”serfdom.” The size of the deficit and debt are viewed as indicators of the encroachment of socialism/statism, and therefore, the approach of serfdom. It is important to understand that this is not only an economic issue in the US. It is fundamentally an argument about political systems. So getting these terms right is important.

77. “I have a problem with the policy objective of stripping income from people who’ve saved.”

    Why is saving a good thing at all?

    I have a problem with people getting something for nothing. Savers get their income from productive capital. The return they get should be a very small slice of the pie, since they take absolutely no risk whatsoever.

78. For a Chicagoish view on the interest rates see The case for and against ultra-low rates – Raghuram Rajan is blogging as well.

79. Just to clarify, the MMT view that the overnight rate should be zero is about setting the rate on risk-free, overnight “saving” to zero. There is no suggestion that this necessarily reduces returns to capital. No MMT’er ever tried to equate the two. It is only a “euthanasia of the rentier” to the degree that rentiers are holding overnight, risk-free investments. I would agree with RSJ that a zero overnight rate would not necessarily hinder returns to capital owners. Separate policies would be required for that. And on that score, MMT’ers like Randy Wray, Bill, Mosler, Bill Black, etc., support all sorts of separate financial reforms that would reduce the % of GDP going to the financial sector.

    (Furthermore, suggesting that MMT’ers want a zero rate, countercyclical deficits, job guarantees, and so forth without dealing with a bloated financial sectors and “money manager capitalism” (as Minsky and Wray call it) is a serious misreading of the MMT macro approach and the policy proposals. It also demonstrates a naivete regarding a number of Bill’s posts here. Steve Keen recently made a similar error in an op-ed he published online regarding us.)

    Also, regarding the “fair rate,” there is no suggestion in that literature that it is necessarily talking about the overnight rate. Mario Seccareccia, a fair rate supporter, has argued that the zero overnight rate and the “fair rate” can co-exist without any incompatibility.

80. “a zero overnight rate would not necessarily hinder returns to capital owners”

    i don’t know how you can say that

    two different systems, one with the overnight rate set permanently at zero, the other with active monetary policy and the overnight rate at, say, 5 per cent at a point in time

    and you don’t think this would affect the interest rate on corporate bonds?

81. not to mention that the cost of equity capital will go down for the same reason

    which will reduce return on equity capital

    does anybody here understand that the return on a risk asset is the risk free rate plus the risk premium?

82. My apologies if my last comment stirs up any anger. I have been traveling the past few days and did not see some of the discussion and only read it after I made the comment. So, let me add a few things:

    Some may be interested in reading “the natural rate of interest is zero” at Mosler’s site, if they haven’t already. The basic argument there is that govt bond sales are themselves interventions to prop up risk-free rates along the term structure. Absent these “interventions,” it is argued, the market would set the overnight, risk-free rate at zero given the view (arising from the sector balances equation–i.e., the non-govt is assumed to desire to “net save” most of the time, and at least over the long run–and the fact that the non-bank public requires reserve balances to settle its tax liability) that the govt’s deficit position will normally be positive (i.e., a negative surplus), and at the very least the public debt will be positive. This is referred to there as the “natural” state of thing. So, far from socialism, the paper argues that a zero overnight rate is the market rate that would prevail under the “natural” state of the govt having a positive debt under flexible exchange rates and issuing its own currency while the govt did not intervene to prop up risk-free rates.

    It is true, and it also is consistent with the paper, that this would reduce the risk-free rate portion of bond rates to zero, and also the expectation of the central bank’s overnight rate component to zero, to the degree that it exists. Again, though, this is viewed as the market outcome under the “natural” state of a positive debt, not socialism. Indeed, the view implied in the paper is that issuing bonds to prop up the risk-free rate is more akin to socialism.

83. Anon @16:45.

    I said “returns,” you said “rates.” A zero rate policy would not necessarily reduce the latter (it could under some circumstances, but not NECESSARILY) but WOULD reduce the latter.

84. Hey Scott,

    I understand that the fair rate proposal is not inconsistent with zero overnight rates. It may involve for example a direct transfer of interest payment from the government to the household bank account, say every fortnight. The government would credit a bank account and the bank’s settlement account at the central bank, for example.

85. Scott Fullwiler –
    Do you have the URL for “the natural rate of interest is zero” at Mosler’s site?

    I’d like to read the original, because your description of it seems absurd – particularly the assumption that the non-govt sector desires to “net save” most of the time.

86. i’m familiar with the zero natural rate proposal, which is consistent with what i’ve been saying about reducing the existing risk free rate throughout the curve

    not sure i understand your returns/rates distinction at the end (i think you meant “former” with respect to returns”)

    if you speak in terms of likelihood, i’d be interested if you agree that a risk free rate of zero will tend to reduce risk rates as well (e.g. government bond yields (or expected short rates) reduced to zero implies corporate bond yield decline as well – maybe not exactly 1:1, depending on everything else that’s happening)

    the return/rate distinction is interesting; if you imagined a shift to zero natural rate one-off, returns could be distorted at the outset. But its basically a deflationary counterfactual (as I think MMT may agree) – cost of capital declines through interest rates at first (risk free and risk), cost of equity capital declines in concert, firms cut prices in response, reducing return on equity, etc. etc. After that “deflation adjustment” is done, the new system works with countercyclical tax policy. But there’s no room for interest income to rise (except for risk premiums). Overall, that will reduce share of macro income to financial capital.

    “natural” is a function of perspective i guess; it does depend on the effective elimination of monetary policy with required slack taken up by tax policy, and it does put the effect of the deficit entirely on the banking system rather than opening it up to non-banks to acquire net financial assets apart from bank deposits

    the “socialism” taint/issue is a low priority thing as far as i’m concerned in this discussion, but i differ there

87. in terms of the deflationary transition to zero natural rate, it might be an idea for MMT to strike while the iron is hot (where hot = already deflated)

    certainly an inflection point opportunity for strategic tax cutting and deficit expansion as a plan

88. Aidan

    https://billmitchell.org/blog/?p=4656

    http://moslereconomics.com/mandatory-readings/the-natural-rate-of-interest-is-zero/

    it’s certainly not absurd; it’s quite rational

    question is whether there are unintended consequences

89. anon –
    https://billmitchell.org/blog/?p=4656
    http://moslereconomics.com/mandatory-readings/the-natural-rate-of-interest-is-zero/
    it’s certainly not absurd; it’s quite rational
    Yes, as I suspected the assumption I regarded as particularly absurd was a misunderstanding on Scott’s part.

    Having said that, I’m far from convinced. Japan’s huge external surpluses limit its usefulness for determining things about the general condition.

    question is whether there are unintended consequences

    There are always unintended consequences.

90. Aidan . . . how did I misunderstand the paper? I helped edit it when Warren and Mat were writing it, so I’m pretty sure I understand the paper.

    The non-govt sector desires to net save most of the time. That’s pretty central to MMT. Also, an external surplus is not inconsistent with this. As Bill notes often, the non-govt net saving = net saving of the domestic private sector + capital account. With a current account surplus = capital account deficit, you can have a smaller govt deficit to accommodate domestic private sector net saving.

    Japan also has, obviously, a large public sector debt, which I said will at the very least be the case (otherwise the non-govt sector is in a position of owing the govt sector on net) even if you string together several years of govt surpluses.

91. Anon,

    Yes, meant to say “former” and then “latter” (duh! sorry).

    My point about returns is that, for instance, you had negative returns to, say, equity for the past few years. So, I am talking about ex post returns there, not a discount rate. Agree with you if by “rate” you mean the theoretical discount rate. Anyway, the point about what happens to returns (ex post) as a result of the zero overnight rate policy is a complex one that I did a presentation on last year. I’ll have to put something together carefully on that to make the MMT point a bit clearer (perhaps Bill wants to try that), but I certainly am sympathetic to your point about risk-free rate plus risk-premium for a required return. That’s obviously pretty standard.

92. Scott,

    “The basic argument there is that govt bond sales are themselves interventions to prop up risk-free rates along the term structure.”

    Yes, they are interventions. But deficit spending by government is also an intervention, as you are increasing the supply of reserves. So regardless of whether a zero cost of reserves is beneficial, it is not “natural” — you are begging the question by assuming that intervening to increase supply is natural, but intervening to reduce supply is not natural.

    In any case, you don’t want to formulate a policy based on this type of reasoning. As the issuer of currency, government must set a price.

93. Scott,

    Are you arguing that the “risk-free” rate for equity *is* the overnight interbank rate? Or that the overnight interbank rate adds to, in an 1-1 manner, the risk-free rate for equity?

    If the latter, then what is the mechanism for this?

    Historically, when bond yields fall below the long term growth rate (over the whole business cycle), then firms issue more bonds, increasing their leverage and also their dividend payments, meaning that the cost of capital increases to make up for the decline in the cost of debt. Capital income shifts from debt to equity. Only when the total capital income falls do both the returns on equity and debt decrease. But you seem to agree that lowering FF will not cause capital income as a whole to decrease. In that case, where does the capital income go when FF is lowered?

94. Above, I meant, “shift their capital structure, issuing fewer stocks and more bonds” — not just issuing more bonds per se.

95. RSJ . . . in the paper, the deficit, or at least a positive value of the national debt, is considered the “natural case” for a currency issuer under flexible exchange rates. So, it’s not an intervention according to the paradigm presented in the paper. To do otherwise would be to put the non-govt sector into a net debtor position with the govt sector.

    Regarding this,

    “Are you arguing that the “risk-free” rate for equity *is* the overnight interbank rate? Or that the overnight interbank rate adds to, in an 1-1 manner, the risk-free rate for equity?

    I wouldn’t argue either point, actually, in the case of the risk-free rate for equity.

96. “To do otherwise would be to put the non-govt sector into a net debtor position with the govt sector.”

    Fair enough, so say you want to run a deficit of X. You can finance that with any proportion of bonds or money that you want. Why again is it “natural” to finance that with bonds and not with money?

    Again, the argument for or against the rate should be based on some form of social welfare maximization, not on what is basically a linguistic tautology.

    re: second point.

    OK, good. If you don’t view the risk free rate for equity as equal to the expected value of FF (which would be FF if that value was constant), then what do you think what happen to the risk-free rate for equity if FF was permanently set to zero?

97. ugh, above should read “why is it unnatural to finance that with bonds and not money” — the point being that any combination is equally “natural”, unless you assume a priori that increasing the supply of money is more natural than increasing the supply of bonds, in which case you are begging the question. I just wouldn’t use that as your reasoning — the reasoning has to be because it improves long term welfare, in which case that should be the argument of the paper.

98. Dear All

    The argument in the paper is from a general perspective, not related to any specific country. In that case, the argument is that the deficit spending creates money/reserves. The choice to issue a bond, or legal requirement to issue a bond, either by the cb or the govt, is an intervention that has the operational effect of propping up risk-free rates, not financing the deficit. The bonds aren’t the natural case in the paper because you need the money from the deficit in the first place in order to buy the bonds anyway.

99. Scott Fullwiler –
    Aidan . . . how did I misunderstand the paper? I helped edit it when Warren and Mat were writing it, so I’m pretty sure I understand the paper.
    You misinterpreted a contingency as a condition.

    The non-govt sector desires to net save most of the time.
    No it does not. There is some desire to save, but the overwhelming desire is to expand.

    That’s pretty central to MMT.
    Were it central to MMT, MMT wouldn’t be much use until it gets rewritten to correct this error. But MMT AIUI does not include this condition.

    Also, an external surplus is not inconsistent with this. As Bill notes often, the non-govt net saving = net saving of the domestic private sector + capital account. With a current account surplus = capital account deficit, you can have a smaller govt deficit to accommodate domestic private sector net saving.
    Of course an external surplus is entirely consistent with this. But proof that policies do or don’t have certain consequences when there is an external surplus isn’t sufficient to tell what the effect will be when there isn’t.

    Japan also has, obviously, a large public sector debt, which I said will at the very least be the case (otherwise the non-govt sector is in a position of owing the govt sector on net) even if you string together several years of govt surpluses.
    And if Japan had run such a large public sector debt without having an external surplus, the yen would’ve collapsed!

100. Aidan.

     Now you’re the one who’s misunderstood. The desire to expand nets to zero in terms of assets and liabilities on the non-govt sector’s balance sheet. The non-govt sector’s desire to net save shows up as a deficit for the govt sector. This is the difference between horizontal and vertical money. Consequently, the desire to “expand” doesn’t necessarily mean that you haven’t net saved.

     Historically, aside from the 1998-2008 period, which is a clear aberration that is now resulting in the “balance sheet recession” (though the seeds of that period were being sown for a few decades) the non-govt sector in the US had virtually always net saved (aside from a few . Note that this does not mean they don’t expand their balance sheets as you’ve said, but that’s an expansion of the horizontal component of money (and to be more specific, within the non-govt sector, the firm sector does procyclically move between net deficits (expansion, as you note) and net saving during recessions, whereas the household sector would always be net saving prior to 1998).

     Regarding Japan’s yen collapsing with public sector deficits and no external surplus, hasn’t yet happened in the US. Your analysis there is far too simplistic. Go see Warren’s new video on his site on the fundamentals vs. technicals for fx.

     You clearly don’t understand much MMT even as you attempt to critique it (or me), so I don’t have much interest in continuing this conversation.

     Scott

101. I am amused by all this. It seems you are talking across purposes as traders promoting their proprietary ideas. Basic economics with circular arguments, no clear assumptions and evasive hypothesis that shifts when needed to bargain the outcome. Half truths………..Discipline! Who Iam talking about? They know!

     One last thought. Vertical generation is a process about quantities based in propensity multiplier and horizontal allocation is a process about price differentials based in preference choice. Both happen jointly and interact with a covariance structure. As about finance of private spending projects there is a whole capital structure theory based on Miller-Modigliani, benefit/cost assessment and “pecking order” allocation subject to asymmetry.

102. Scott,

     the government does not need to spend “first”.

     This is again a stock/flow issue. The stock of money does not need to increase or decrease in order for the government to create any given flow of spending.

     As long as there is even $1 of surplus cash in the economy, the government can sell $1 worth of bonds, and then spend the dollar. Wash, rinse, and repeat.

     That excess dollar can generate an arbitrary level of deficit spending.

     Alternately, the government could add a dollar and then sell a bond, and repeat that process.

     Both of the above processes are equivalent.

     Or the government could increase the supply of dollars. The government can do all three.

     Which is “natural” is completely subjective. Whichever you prefer is natural.

     That’s not an economic argument for a zero FF.

     You need to make an economic argument — that a zero FF will promote employment, or increase output, or improve social welfare somehow. You don’t make a radical change like this because you happen to have a personal preference for option 3 versus option 1 or 2. That is the intellectual equivalent of favoring a proposal because it rhymes.

     The only real argument presented in the paper is that it reduces rentier incomes, which is fallacious. I wonder why you couldn’t talk some sense into Randy Wray (and our host) about this. And the same goes for many of the other PK commentators.

     And as you agree that zero FF would not reduce capital income, you have no argument for doing it — as far as I can tell.

     But I would be interested in hearing any economic arguments in favor of this. Perhaps there are some.

     And still, the question remains — what do you think would happen to equity returns if FF was permanently set to zero? What do you think would happen to 10 year debt? Would it be, as anon argues, that interest rates would only reflect credit risk, and therefore your mean return will be zero? Would the mean equity return increase or decrease?

     This whole debate highlights the danger of making macro deductions based on stereotypes and rules of thumb. For every “rentier” that is receiving interest, there is another rentier paying interest. Lowering a firm’s interest costs will increase the firm’s dividend payout. Giving a landlord lower mortgage rates increases the landlord’s net rental income. So in aggregate, capital’s share of income from all sources will not increase or decrease as a result of FF movements. And households are free to purchase any asset, from bond funds to equity funds to REITs. They will shift their portfolios, bidding up the price whatever asset class happens to be subsidized, and bidding down the price of the asset being penalized. These shifts will counter the shifts the government is trying to create, so that total return will remain remarkably resistant to government attempts to control yields.

     For purposes of distribution, what you want to look at is the total income of the household, not the instrument that the household purchases with its income. Taxation is how you reduce inequality.

103. Not sure of a few things, though I think I am with anon on this.

     There is a high chance that corporate credit market yields will come down. If the 5y corporate spread is 100bps, and the 5y govt bond yield is 4%, high chance that in the no bonds scenario, the corporate bond yields are something like 1-2%.

     There is a historic proof of this. In the 70s, the banks lost to commercial paper funding because producers discovered that it is a cheaper source of funding and the interest rates on this was between the T-bills rates and the bank loan rates.

104. RSJ @ 9:10,

     There is a lot of literature in Modern Money starting with Minsky regarding interest rates and the effects of central banks making rate moves. Don’t have them with me but have seen a lot on it. Plus there is enough material on this blog, Bill’s books as well on the effects of interest rates. There is a lot out there!

105. Some clarifying points.

     1.The growth term of nominal yield rates decreases asymptotically to the CB lower bound as the short term declines to the zero interval. (What is the growth rate over night?).

     2. As the time term of the security extends there are additional factors to the risk free term including credit risk (with an expected shortfall term), interest risk with a probability of duration and current duration calculation, exhange risk, inflationary expectations, etc. THe government looses control capability with rising maturity in primary market auctions and with duration in secondary markets regardless of substitution options. I have mentioned all this before in other comments. Notice that there is even a purchasing power term which rises asymtotically as the expected duration declines.

     3. Excess dollar, wash, rinse and repeat. How did the excess dollar come about? If the government can spend by crediting accounts or printing cash why discuss a seperate increase in the money supply? How this will happen? The government will borrow from itself via the CB? Is this optimal? Optimization requires least effort! Natural, implying less resources used, is the least effort!

     4. As I have argued in an earlier comment in a previous blog post all taxation is mainly distributional (preference) at discretionary tax rates in nature and should not be confused with spending injections of fiscal stimulus and endogenous fiscal spending (propensity) which is mainly vertical in nature. It is not proper mix the analysis in terms of a deficit distinction. The tax rates upon income (non lump sum) including tha rates on sales and the automatic fiscal spending coefficient modify the income multiplier and the fiscal spending injection is either an exogenous stimulus based on state purchasing plans or can be viewed as an automatic feedback to a demand failure to achieve full employment.

106. Ramanan,

     I know that there are many words out there, but I don’t think the word “equity” is mentioned once when discussing yields. Neither is opportunity cost, or endogenous capital growth. Strange. I’d like to hear what Scott thinks would happen to equity in case FF was permanently set to zero.

107. corporate paper is not 5 year debt. Paper is short term debt — e.g. up to 270 days.

     You actually gave an example of the government attempting to control yields (by making it illegal to pay interest in deposit accounts), and households responded by buying money market funds that paid a positive yield. I.e. this is an example of the government failing to control interest rates. The fact that banks must compete for deposits is also overlooked — e.g. deposit rates were higher than mortgage interest rates in Australia recently. Even though the banks are captive and can be forced to bear excess reserves, households are not forced to hold deposits or to buy corporate bonds. They can always buy equity, or invest in funds that buy equity and issue shorter term obligations, and in this way, shorter term yields are pushed up by the equity yield whenever the government tries to push the shorter term yields too low.

108. You say nobody talks about equity.

     Yet the theory of capital structure discusses the options of financing with equity as I have mentioned several times. The question is if there is an advantage to order the means of finance. What is your hypothesis and why?

109. P,

     By “nobody” — I was referring to the MMT camp. It’s really bizarre, as I asked a question about what would happen to equity, and got answer about 5 year corporate debt, and this was supported by a “historical precedent” using commercial paper (!).

     In terms of my own hypothesis — I want to first hear what Scott and others believe will happen to equity yields if FF is permanently set to zero.

110. Why wait for Scott? Given your interest and discussion in the topic I am sure you must have hypothesis behind it. I do not challenge you. I am interested to know. For example is there a preference for a firm to issue equity first, second or last, the others of course being retained earnings and borrowing. For example Miller-Modiglianni originally thought it made no difference and then gave an order of preference in favor of debt because of the tax treatment. Sources of imperfection also matter as the “pecking order” hypothesis which is based mainly on asymmetry. I have been looking of how the other sources affect the order. Also, does the order of issue affect the order of portfolio allocation of the demand side, including financial intermediaries?

111. Because, P, then we get into a debate about my theories, whereas I am trying to pin down the MMT view. The reason I asked Scott specifically was that he at least acknowledged that capital income does not rise or fall when FF changes.

     This is a serious breakthrough vis-a-vis what Bill or Randall Wray believes. In fact, Scott is the only one who acknowledged this AFAICT, and it’s a testament to his integrity that he is willing to follow the data where it leads.

     It would require a lot of fancy footwork to argue that yields from all assets would fall when FF is zero while simultaneously believing that capital income would remain constant.

     I want to see that footwork in action. And who knows, perhaps I would learn something.

     But I will post something about what I think in some other blog post here.

112. We all learn something if we have an open mind, assumptions and a hypothesis to propose which others can help us correct. The purpose should not be to challenge anybody to display their fancy footwork. We are not traders of proprietary ideas to score points but free thinkers wanting to share. We are not working to promote ideas seeking a reward but donating idea/opinions expecting grace in return. In a summary, we should be a community of thinkers not a market of promoters.

113. I agree, P, so let’s find out what the MMT proponents believe will happen first to capital’s share of income and second to equity returns if FF is permanently set to zero.

114. RSJ, perhaps I am naive, but what difference does it make? It seems to me that this is a market decision and not something that the government (including the CB in government should be involved. As I understand it, interest rate setting by the CB was a feature of convertible fixed rate currency that no longer applies. The government now sets rates as a matter of financial engineering, and in doing so uses unemployment as a tool. Why not just get the government out of the business (including no bonds). This would would be tantamount to letting the overnight rate fall to zero, considering that fiscal policy to produce full employment with price stability would pretty surely involve a constant deficit, hence excess reserves.

115. RSJ,

     There are some papers in the PK stock flow consistent models which talk of equity. If you have jstor access you can try Kaleckian models of growth in a coherent stock-flow monetary framework: a Kaldorian view by Wynne Godley and Marc Lavoie.

     Here is the abstract

     Abstract: This paper presents a demand-led growth model grounded in a coherent stock-flow monetary accounting framework, where all stocks and flows are accounted for Wealth is allocated between assets on Tobinesque principles, but no equilibrium condition is necessary to bring the “demand” for money into equivalence with its “supply.” Growth and profit rates, as well as valuation, debt, and capacity utilization ratios are analyzed using simulations in which a growing economy is assumed to be shocked by changes in interest rates, liquidity preference, real wages, and the parameters that determine how firms finance investment.

116. Ramanan, I know this model — but what are your beliefs? Do you argue that if FF were to be permanently zero, that, either

     a) Capital’s share of income would change, or
     b) It would not change

     In case of b), which assets would see increasing returns and which assets would see decreasing returns? Why would households buy the assets with falling returns and not the ones with increasing returns?

     In case of b), how would it change and why?

     This is not a trick question — I am honestly trying to figure out what you believe. I know what Warren M. believes — he believes a) would decrease, and that households would park investment funds in bank deposits and accept the low rates — good that he owns a bank! But what do you and Scott believe?

117. RSJ,

     I don’t think that setting the FF permanently to zero will necessarily affect capital’s share of income. I thought I had said that already. I think other policies are necessary if that’s a goal.

118. RSJ, isn’t it that at the very least FF rate at zero will decrease the capital’s share of income simply because the flow of income from the government to private sector will be lower. With regards to the rest (i.e. private sector) you seem to be right about pure redistribution of capital income between different capital instruments without any affect on total volumes.

119. RSJ,

     It is time that you come forward and present your position on equity and the capital’s share with assumptions, hypothesis and why. This way you can get some response to your concerns. It is not clear to me what is your position. Challenging others is not enough, share with us your views……..it will also help yourself if that is your purpose.

120. Ramanan,

     This is a good paper. It is too bad Godley has parted for other fields………In memoriam.

121. “I don’t think that setting the FF permanently to zero will necessarily affect capital’s share of income. I thought I had said that already. I think other policies are necessary if that’s a goal.”

     You did say that, but I think you contradicted it.

     My view is that it isn’t a question of being a policy goal; it’s one of it being a very likely outcome of the zero rate policy.

     First, rates on risky fixed income assets equal the risk free rate plus a credit spread.

     So if the risk free rate drops permanently to zero, it seems very likely that rates booked on new risky assets will drop. That’s not to say there won’t be some adjustment in credit spread risk premiums, but it’s not logical to expect a complete offset as an outcome. I thought you agreed with this more or less.

     Second, expected return on equity assets is equal to the risk free rate plus a risk premium. Again, for the same reason as fixed income assets, it seems very likely that expected and realized equity returns will decline as a result of dropping the risk free rate to zero. It’s not logical to expect risk premiums to increase as a complete offset.

     I thought you agreed with the gist of this as well.

     Finally, some people seem to be under the impression that a decline in the fixed income component at the macro level must be offset by an increase in the equity income component. This is quite funny, because it reminds one of the “Treasury view” of government deficits. Obviously there is an output/income identity in the national accounts. But an identity doesn’t mean things don’t adjust along the way – something which Krugman had to point out to the Chicago school a while back. In this case, zero risk free rates are a deflationary income shock that would result in likely relative price declines and relative upward wage pressures through competitive forces – because without these further adjustments, return on equity would be too high (and too attractive for new entrants to ignore) relative to fixed income returns.

     (I’d be interested in an example or two of those necessary policies you refer to.)

122. P.S.

     “I don’t think that setting the FF permanently to zero will necessarily affect capital’s share of income.”

     “necessarily” is a bit of a hedge.

     Nothing that is uncertain is necessary. But wouldn’t you agree it’s likely in this case?

123. “This is not a trick question – I am honestly trying to figure out what you believe. I know what Warren M. believes – he believes a) would decrease, and that households would park investment funds in bank deposits and accept the low rates – good that he owns a bank! But what do you and Scott believe?”

     Let’s look at Japan – zero rates and the public parks their funds in the postal bank – good that the public there owns (sort of) a bank. I can’t see how capital’s share of income (vs. composition within capital – rents, interest, profits) would necessarily change, unless other political constraints are put in place.

124. Anon,

     It is not clear how the risk free rate will go to zero without an asymptotic adjustment for the growth rate, given the term structure. For example, the LT rate has a risk free term which is equal to the trend growth rate and this term declines in importance accordingly as we shorten the maturity and duration of the security in question. THIS HOWEVER DOES NOT ALTER YOUR POSITION, SO WHY ARGUE ABOUT THE RISK FREE RATE? The CB controls only the very ST for which the growth term is insignificant. The question is whether, the income lost from non payment of interest comes from replacement of reserves and cash issued rather than LT bonds when the fiscal authority net spends. It is possible that lower ST rates from Monetary Policy can result in higher investment spending and profit income can replace the lost income from public debt. However, this depends on how responsive is investment spending to ST rates given “animal spirits” (beliefs) and MEC and limitations imposed from collateral asset values and financial leverage of private spenders. So what happens is MAYBE. Unless anybody else has a clearly stated hypothesis with expicit assumptions we cannot CLARIFY WHAT ARE YOU GUYS ARGUING ABOUT.

125. Why are you trying to incorporate growth in fixed income returns? Fixed income investors get compensated for credit risk, interest rate risk, inflation, and inflation risk. Not growth.

     And what is compensated assumes its a market determined rate.

     The short term risk free rate is not a market determined rate. By construction, there is no credit risk, and investors are not compensated for the other risks because pricing is not market determined.

     Furthermore, assuming the central bank commitment to a permanent zero short rate is credible – and that is the working assumption here – there is no interest rate risk. So forward rates should be the same as the short term cash rate, and the yield curve should be identically flat and zero rate.

126. Anon,

     I agree with you on the fall of other interest rates. As you pointed out, it will also lead to a drop in costs. However, I think that producers may just increase the markups. I don’t see why the class which earns interest income will not earn less – its income will go down, and I don’t think such a thing is inconsistent with what I have seen in Post Keynesian Economics.

     As far as equity is concerned, I guess in advanced economies, equity has already been thought of as the costliest route and avoided as much as possible. As far as corporate debt is concerned, I don’t see why investors’ animal spirits won’t go high and soon, they will find that its the place to invest if yields remain high and hence this class with bring down the yields. This class may also give banks a run for their money.

     So I agree with your comments.

     As far as interest rates are concerned, its the rentier class which lobbies for higher rates because that gives them higher incomes. The central bank is just dodging its objectives of full employment and pressure of the lobby group.

127. “So I agree with your comments.”

     What fine judgement you have 🙂

     I’m wondering what the MMT’ers expect retired people to do. Invest in equities only? “Rentiers” include retirees. Last time I checked, that includes common folk in addition to fat cat bankers. I’d like to know more about the Mosler plan for that.

128. P.S.

     I get the distinct impression that a core part of the MMT agenda is to punish rentiers with a broad brush.

     I’m not sure that’s a very healthy strategy. In fact, I’m quite sure it’s not.

129. “I’m wondering what the MMT’ers expect retired people to do. Invest in equities only? “Rentiers” include retirees. Last time I checked, that includes common folk in addition to fat cat bankers. I’d like to know more about the Mosler plan for that.”

     The most sensible approach is to have a living state pension, which is exactly the same as paying index linked yields on gilt, but it cuts out the financial middleman.

     And then yes they would have to invest in equities – you know real business that generate real profits and pay a real dividend, while at the same time employing real people. That would get businesses away from the stupid asset stripping leverage dash for cash capital growth system we seem to have ended up with.

130. “I get the distinct impression that a core part of the MMT agenda is to punish rentiers with a broad brush.”

     MMT is just a theory of how money works. It gives some interesting insights – that a sovereign nation is not financially constrained and that the exchange rate is another buffer against systemic shocks that shouldn’t be locked out.

     How it is used depends on your ideology. Whatever the ideology, the way money works stays the same.

     The rest is politics. What are the arguments for rentiers earning money off other people’s backs. I can see an argument for rentier getting paid if their investment provides jobs for other who cannot create one themselves. I can see an argument for a rentier getting paid for providing decent housing for people to live in. I can’t see an argument for them getting paid for dominating a monopoly resource or constraining access to ideas or other systems of production (copyright on ‘old’ material for example).

131. “So if the risk free rate drops permanently to zero, it seems very likely that rates booked on new risky assets will drop. ”

     Wouldn’t the adjustment come through the shift away from monetary policy to the fiscal taxation regime.

     For example you could have 0% interest rates and a land value levy charged to freeholders that the central bank adjusts (since land is a monopoly resource and the basis of all production – mostly in the form of housing). If that levy was tax deductible then you would see roughly the same effect as having interest rates set positive but it would affect a different demographic.

     A policy rate is just a tax at the end of the day.

132. Anon,

     This is a good article: The Political Economy of Interest Rate Setting, Inflation And Income Distribution (pdf)

     It however doesn’t go into whether its a healthy strategy.

133. “MMT is just a theory of how money works.”

     I know,

     but –

     in theory its a theory; in practice its an agenda

134. “What are the arguments for rentiers …”

     Rentiers are savers.

     What are the arguments for punishing savers?

     Why should savers who outsource their investing be punished for it?

     Do you have to own a steel mill in order to save without being punished for it?

135. Ramanan,

     thanks for the article ref.

136. Absolutely there is a contradiction in the view that capital income’s share will remain constant and the view that the expected return — for all maturities, including equity, are set by the expected FF over that time horizon.

     Fortunately, it is clear which theory has empirical support. Capital income does not decline when rates fall — in some countries it even increases. Moreover, the profit rate is the growth rate of the economy — this is the Cambridge rule. You learn this in freshman macro when you study the Solow model, or if you want to be heterodox, you get the same result in Harrod’s knife-edge model, the Goodwin predator-prey model, or even Kalecki’s markup model. A more modern version is from Romer’s 1990 endogenous capital growth model.

     They all have the same result — that the profit rate is equal to the growth rate. OK, that is theory, but what about evidence for the golden rule? I once remember reading a paper called “Limits to Central Banking” by either Lavoie or Godley — I’m sure Ramanan has the reference ready — in which they applied an HP filter to equity returns and long term bond returns and found that they supported this.

     You can do you own analysis. If you are looking at long time periods, then long term bond yields and long term equity yields are equal, both ex-ante and ex-post, and both are equal to the NGDP growth rate over the period.

     We can get into a whole discussion as to the absurdity of the model that long term rates are expected fed-funds. First, fed funds is not an investor rate, but an interbank rate. The 0 day interest rate for investors is MZM own rate, so to be consistent, you should be arguing that expected values of MZM are what counts.

     The actual mechanism by which FF affects other rates is arbitrage by the banks. Now if banks had no capital requirements and no regulatory requirements, and could borrow without collateral at zero interest rates, then they would buy up all the assets. In that case, yields would be zero, or rather undefined. Only in that case can you argue that expected FF = interest rates.

     But in order to prevent that, we impose costs on banks in terms of setting aside risk capital and we limit what types of assets they can hold. So banks cannot arbitrage with FF alone — the true cost of arbitrage is FF + other costs + regulatory limits — not just FF. When those other costs are too low, then capital income does not fall, it gets re-routed into the banking system, away from one set of rentiers and towards another.

     So I would say that the natural zero day rate of interest is zero — checking accounts should pay zero — but the natural fed-funds rate is not. Instead, talk about FF + other costs. Those costs should be such that the total cost to the bank of extending a loan is equal to the expected growth rate of the economy. Depositor banks should only be holding loans they make to term, and should not be allowed to purchase credit-market assets. And one way you can accomplish this is to impose asset taxes as well as other extra profit taxes on banks to prevent them from using their CB backing in order to obtain greater profits than the productive economy.

     Absolutely agree that punishing rentiers is bogus objective. The problem is not a shrinking of wage income, but the distribution of that income. And you don’t care if a CEO gets paid excess wages or if they receive excess dividends. What you should be trying to limit is economic rents, whether those be from capital income — i.e. when bank marginal costs are too low — or from wage income paid to top earners.

137. “the view that the expected return – for all maturities, including equity, are set by the expected FF over that time horizon”

     You remain confused. I’ve said nothing like this at any time.

     You don’t seem to grasp the concept of a risk premium over the risk free rate.

     “We can get into a whole discussion as to the absurdity of the model that long term rates are expected fed-funds.”

     Again, you are confused. I would never say this about the existing active fed funds anchored monetary policy.

     But it certainly applies to a system in which the government effectively abandons modern central banking and commits to a permanent zero rate on banks reserves.

138. “Moreover, the profit rate is the growth rate of the economy – this is the Cambridge rule.”

     I don’t have a problem with that. It may be bullshit for all I know, but I don’t object to it.

     What I know for certain is that I’ve said absolutely nothing that contradicts it, so I don’t know why you bring it up.

139. P,

     In terms of what I believe, I would say that “to first order” — e.g. in a toy arbitrage-free model — the equity returns are endogenous and that the discount rate for equity is the expected growth rate of the economy.

     The NPV is not discounted by the interbank rates, but by the overall expected growth rate. So that, if you have a firm, it will continue to expand its capital stock, and as it does so, the return on capital — for that firm — will fall up until it hits the overall expected return. I.e. as an axiom, any expansion of capital must be because it is earning a return greater than the overall return, and that the capital stock will continue to expand until it hits the overall return from below.

     With many overlapping firms or varieties of capital, new ones are being born, encounter increasing returns, then decreasing returns and hit the expected growth rate from above. So the market value will be determined by that terminal capital size at which point expanding the capital stock will is no longer profitable. So say the overall growth rate is 5%, and the small firm now has 1 unit of capital that yields 6%, and if you increase that to 10, you max out at 10% and then you keep increasing it until you hit a average profit rate of 5% when you have 20 units. If this whole process is expected to take 10 years, then the market value would be the present value of $20 discounted at a rate of 5% over 10 years, as you are being promised delivery of 20 market consols in 10 years, each paying 5%.

     None of this has anything to do with interbank lending rates.

     For shorter term maturities, you can get an arbitrage-free yield by assuming that the firm can speed up the process of growth if it takes out a loan rather than funding itself via retained earnings, and this will increase its equity value. On the other hand, the firm must repay the loan, decreasing its market value. In an arbitrage-free context, this change in capital structure will not cause the equity value to either increase or decrease, and from this you get an increasing function of the interest rate as a function of the repayment time.

     With a distribution of firms, you can still calculate an expected yield for each maturity. All yields will be discounted by the overall growth rate of the economy together with the rate at which the marginal product of capital diminishes.

     That will get you a simple, idealized model of equity returns and a yield curve — an arbitrage-free model. Not the actual curve, which is subject to government forces. This is perfect future knowledge model, too. I.e. even ignoring risk, a growing economy with growing firms will have a positively sloped yield curve and a non-zero interest rate.

     We do have banks and they do arbitrage with CB backing, by purchasing longer term assets from shorter term funding. But simultaneous to that, this encourages debtors to shift their capital structure to take advantage of the lower funding costs, undoing some of the arbitrage. Whatever remains is an economic rent taken out of the productive economy and put into the banking system. Such a rent will eventually cause the growth rate of the economy to fall. So in terms of the “natural” rates of interest, they should prevent any economic rents from going to the financial system. And this works in the opposite direction as well — when FF is hiked too high, you get a banking crisis. The total costs imposed on banks should be neither too high nor too low, but in line with the cost of capital of the productive sector, so as not to interfere with arbitrage-free interest rates

     Now, in addition to this toy model, you would look at all sorts of psychological, behavioral and institutional factors — that is fine, but at the end of the day, you do not need to rely on these factors to explain either the equity returns or the basic form of the yield curve, or the fact that equity rates average out to be the economic growth rate for developed economies. Or the fact that for any particular firm, the internal rate of return is greater than the overall market return — by about 3%. These stylized facts can be modeled well by a simple overlapping capital model, and that’s how I tend to view things as a baseline case.

140. Anon, “I’m wondering what the MMT’ers expect retired people to do. Invest in equities only? “Rentiers” include retirees. Last time I checked, that includes common folk in addition to fat cat bankers. I’d like to know more about the Mosler plan for that.”

     In a market free of interest rate setting by a small group of technocrats, retirees will do what everyone else does, that is, act in whatever they consider to be in their best interest vis-à-vis free market opportunities. Isn’t that what a free market is about?

141. Anon, At your comment of@1:04,
     Who are you addressing? If it is a response to my comment you are obviously confusing what I say. I suggest you read it more carefully since I clearly stated that the growth rate is not relevant for the very ST rate which can be controlled by the CB. AS about the longer term rates I have repeatedly presented my hypothesis even mathematically with a more elaborate and complex presentation in my theoretical work. I even pointed out to you that your preoccupation with the rates is not essential for what it seems to be your point regarding the lost income from public debt. PLEASE STATE CLEARLY YOUR HYPOTHESIS AS I HAVE ASKED RSJ TO DO. HTEN YOU WILL RECEIVE AN ANSWER FROM ME, AGREEING OR NOT.

142. Anon, you are hopelessly confused. The “risk-premium” is just credit risk, and this goes away when you look at expected return. Obviously for any given issuer, they will be charged a premium due to the possibility of default. So what? We are talking about the return ex-post — that is what investors are really buying. In terms of the other comments, you can review your own posts earlier in this thread.

     Under no circumstance past, present, or future will the return ex-post be equal to expected interbank rate movements. The profit rate will be the growth rate of the economy over long time periods, and the only question is 1) how much of that is diverted into the financial system as economic rents and 2) how will investors shift their holdings to counter the government imposed subsidies and penalties. It may be that banks buy all the assets and everyone invests by buying the banks — that is one extreme possibility. But what is more likely is that equity in general grows and fixed instruments in general shrink somewhat. I don’t think they would shrink too much, since you can create mutual funds to buy equity and issue debt claims to investors, if investors prefer to hold debt.

143. Anon: “I get the distinct impression that a core part of the MMT agenda is to punish rentiers with a broad brush.”

     From what I understand about MMT, I’d say instead that a core part of MMT is to balance output (growth), employment, and price stability so as to reduce/eliminate foregone opportunity and inefficiency in the use of resources, natural and human, while at the same time keeping the currency/price level stable. A by-product of this would be to increase investment opportunity. If it is an objective to “reduce rentiers’ income,” it is in the sense of replacing unproductive rent-seeking with productive investment. What am I missing?

144. RSJ,

     You have presented assumptions and a hypothesis, so we can talk. I am not sure I follow all of it but here are some observations.

     1. I find your assumptions regarding the ‘toy” model rather unrealistic including the arbitrage free arguments, perfect knowledge, etc. I understand however, that this is a first pass.
     2. The analysis regarding the role of the growth rate and rents in estimating equity values is something I can AGREE with some qualification of the degree of persistence regarding market power and the effects from imperfection and complexity. There can be persistent equity differentials among firms.
     3. It is not clear if you have an order of the sources of financing of investment plans as the capital structure theory debates. Does the firms in your scenario use an order such as retained earnings, debt and equity finance or some other and why? For example,does your hypothesis accept that are benefits from taxation, financial leverage or the financing mix is neutral? How sources of imperfection and complexity affect this order of the capital structure in addition to the yield differentials among these asset classes? For example, some assume that equity finance has a higher risk than debt finance and that risk adjusted differentials are not equated. Does your hypothesis determine who sets the issue terms, the quantity of the security issue and how much is purchased by financial investors and intermediaries?
     4. When you say “overlapping model” are you refering to a model with a generation survival rate of owners(households) as in Blanchard (1985)? Is the survival rate (i.i.d) as usually assumed in these models to assure stationarity?
     5. The averaging out of equity rates to the growth rate is some long term steady state rate? Are you using some adaptive exponential smoothing factor term that decays as time gets very large?

     If the discussion procceeds I can undestand more and maybe I have some constructive suggestions, assuming you want them.

145. P,

     That’s a lot of questions! First, there is the issue trying to make simple models, and then there is the issue of interpreting the real world. What’s most interesting to me know is making simple models, with the smallest possible set of assumptions that can explain the stylized facts that we see. This means no tax distortions and other effects that you describe.

     I think one problem with heterodox economists was that they looked at the models, didn’t like the effects that they saw, and just assumed that the reason reality differed so dramatically from the model was that the models didn’t incorporate enough complexity. I don’t think this is the case. I think the micro-foundations are wrong. If you fix them, you can still get the basic effects that are observed. And I am trying to do this with the simplest set of assumptions possible.

     When talking about actual markets and prices, it becomes a bit hopeless since no effect will be able to generate a model that either correctly predicts asset values nor a model that correctly predicts their variance — which may well be infinite. We have no idea what the actual distribution of returns is. As soon as you assume what it is, then you are already working in a highly stylized context, and adding additional baroque details may or may not make the model “better” — it may just make it more complicated.

     In terms of funding priorities, I’m assuming that there is an initial endowment of funds raised by selling equity. If you assume that the average (financial) returns are a concave function starting at 0 when the capital stock is small, and with a unique maximum, then you can show (e.g. prove) that optimal equity investment is when the average return hits the consol rate for the first time. So all firms would start with the capital stock at this level.

     Thereafter, the firm is free to capitalize itself with any combination of bonds or retained earnings. The condition that the choice of one or the other will not affect the enterprise value generates the arbitrage free rates for bonds for that firm. You can then take the expected value for all firms to get the average market rate. Again, all of this is an attempt to show that yields are driven by the characteristics of production and growth in the real economy, rather than an argument (as many PK models have) that yields are exogenous. Of course yields are subject to manipulation, but to the degree that they deviate from the endogenous, or natural yields — this just means that someone is earning economic rents. Rather than trying to “set” interest rates we should be very careful that our policies do not cause interest rates to deviate from their arbtrage-free levels. In the ideal case, welfare is enhanced when the government interacts with the real economy via fiscal policy, and CB-backed banks are prevented from either buying or selling debt, but are only allowed to sell equity and issue mortgage and small business loans according to government supplied standards.

     In terms of overlapping generations, I’m not using the discreet model here, but assuming as per Romer that there is some form of invention model. In my case, a simple invention model would be a random variable taking values in the concave return functions. From this you get a consol rate. Then you start with some distribution of firms, and can determine how many new forms of capital are created rather than adding to the existing forms. So the invention model is the oracle, and you are creating a flow of new forms of capital while also increasing the flow of the existing forms of capital. The arbitrage-free condition can then be used to determine — in the ideal case — how much of investment is directed at existing firms and how often you call the oracle. P/E ratios should neither rise nor fall, but if you make no calls to the oracle, then they will fall whereas if you only make calls to the oracle, then they will rise. There is a unique steady state in terms of flows here, and this state will determine the growth rate of the capital stock. Then you can see how a change in the distribution, e.g. due to a stochastic shock, will trigger a change in investment rates.

     Again, these are very simple models, but the point is to see how far you can get with the simplest set of assumptions. Then you can add more and more baroque features on top of that — asset bubbles and financial panics, etc — assuming you have a solid base.

     But the simple point here, whether you agree with any particular model or not — is that returns — at all maturities — are determined by the assumption that the model is arbitrage-free together with the characteristics of capital growth. Any deviation between the arbitrage-free rates and the actual rates necessarily supplies economic rents. The most fair policy is to minimize these economic rents — i.e. to let all credit market rates float, by preventing banks with access to the discount window from participating in these markets. If you put enough of a wall around banks and the credit markets, preventing them from issuing paper or any liability other than equity, and prevent them from holding any assets other than public purpose lending, with special taxes levied on banks and dividend restrictions, then you can set the marginal cost of reserves to be whatever you want and the credit market rates will continue to float.

     What we have now is arbitrage, with enormous economic rents being funneled into the financial sector, as the banks have lower funding costs than productive enterprises, and they use the lower costs to evade regulation and buy up assets.

146. Anon

     “What are the arguments for rentiers …”

     Rentiers are savers.

     What are the arguments for punishing savers?

     Why should savers who outsource their investing be punished for it?

     Do you have to own a steel mill in order to save without being punished for it?”

     Why should someone who forgoes consumption today (presumably because the dont need to consume) be guaranteed the ability to consume the same level in the future? Saving is great, consuming only what you need is great (reduces waste) but I have come to the view that savers should not expect nor should they complain loudly if they are unable to consume the same level of stuff at the later date they choose. Its not savers who should run the economy any more than consumers.

     I find it interesting how inflation is often referred to as a form of default or punishment to savers. Does this make deflation a form of usury and an excessive reward to savers? All the inflation fears we’ve had have placed a deflationary bias to our economy. All this does is further hurt people with private debt and increase risks of default.

147. Well, Greg, historically the bias has been towards inflation, and not deflation.

     But that bias is primarily due to credit growth. It is credit growth that forces the hard powered money to grow. But you are right, the only way to “save” is to dig a hole in the ground, put all the food and clothing you want to consume later into the hole, and then dig it up when you retire.

     Of course, you need to post guards around the hole, pay them, and also rent the hole. And you will find that the goods put into the hole deteriorate with time.

     The only way to get a return is to invest. If you invest, you will get a positive return in a growing economy, but that same mechanism will create inflation that will eat away some of that return. In the end the savers expect magic — they want a credit-based economy that allows them to invest, but they don’t want the inflation generated by credit-growth. They are not happy with the real rate of return, which is positive, at say 3%, but is volatile. They demand the nominal rate of return, or 6%, without the volatility. To them, anything less than the nominal return is robbery, when they should be happy for the real rate of return. That is much better then the alternative, which is to start digging.

148. Anon,

     It don’t see it as an agenda. It seems to me that the shifts in the distribution of income throughout the last 30-40 years has been very high. The recent decade has shown that. My view is that this decade it will be accelerated. For example, Bill pointed out in one comment that the oil sellers will greatly threaten the growth of world economies. The distribution is going in an unsustainable path.

     The way the monetary system works, it is not difficult to achieve win-win-win situations.

149. RSJ,

     1. Regarding assumptions. Assumptions must be realistic and conform to what is observed and not as Freidman (by the way, a teacher of mine) test a model with simplistic assumptions based on statistical evidence. A model must be based on the dialectical method where the assumptions interact with logic to lead to a hypothesis. You incorporate imperfection and the resulting complexity not as an add on but as primary essentials of any analysis. Otherwise it is only a “toy model” as described yours. Ideal circumstances are not reality.
     2. Not all PK models incorporate the interest rate as arbitrary. For example, the “fair rate” estimation is based on real productivity growth. See my next comment on the risk free interest rate for references.
     3. Let us talk arbitrage because you base your analysis on it. Is arbitrage costless and “naked”? If yes, bank market power is not the only source for a rent premium. Arbitrage and collateral cost adjustment must be included in rate differentials. Floating credit rates will not eliminate the rent differentials not even deal with the market power of finacial intermediaries.
     4. You do not have any answer to the order of finance and you do not even incorporate any financial layering or even a Minsky based differentiation of the types of finance that can lead to finacial instability. There are differences that must be incorporated as debt benefits from interest payment tax deductions and other trade offs imposed by imperfection and complexity as the ‘Pecking Order” approach. Instead you are refering to an ALL EQUITY finance which is not what we obseve. Notice that the structure of finance is critical for the capital structure and real economic activity and growth.
     5. You are using the random/stochastic model of invention (Romer) of capital formation. Where is pure uncertainty, convention, “animal spirits” and beliefs in your analysis? You do not mention them. Where are “random jumps” which are important in invention and they lead to a Power Law specification of the model and can bring instability.
     6. What is your model specification for the adjustment to the LT growth term? In my previous comment I asked if you are using an adaptive exponential smoothing strategy. I assume you are using an instaneous adgustment based on rational expectations.

     I hope my comments help you in your efforts.
     5.

150. RSJ,

     I should have said “…..costly and “naked”?” Sorry for the mistake.

151. ON THE RISK-FREE INTEREST RATE.

     1. A risk-free rate or the term of a rate for a security that if held it imposes no risk of price/exchange variation or default and is completely and without cost acceptable as a means of payment.

     2. A risk-free rate CAN include a term for time preference. Assuming time preference for holding securities implies that there is a preference for immediate rather than delayed spending (Assuming transversality). Thus the longer the holding period (duration/maturity) of a security, the higher the time preference discount factor. Alternatively, a security with nearly immediate repayment on demand has a time preference discount that converges asymptotically to zero.

     3. A risk-free rate CAN include a term for growth as a security is an equivalent to a deffered command over resources whose productivity during the delay period corresponds to the compensation for holding the security. Again, a very ST security has a very miniscule growth term compensation corresponding to the miniscule productivity performed during the very ST and this term converges asymptotically to zero. This is equivalent to the “fair rate” estimation, see Lavoie, Seccareccia (1999).

     4. NOTICE that the very ST which is also near free-risk rate such as the Federal Funds rate, CAN approximate a “natural” rate of zero. See Mosler, Forsteter (2004) and Atesoglu, Smithin (2006). This implies, as per previous points, that the rate incorporates NO RISK, NO TIME DISCOUNT AND NO PRODUCTIVITY COMMAND during this nearly immediate time period.

     3.

152. ADDENDUM TO THE RISK-FREE RATE.

     I have excluded the inflationary expectations term from the analysis as I deal in nominal rates and any inflationary risk I include in the risk category. Obviosly, also the growth rate here is a nominal value.

153. Ramanan,

     The annual US gov deficit interest cost is about $ 300 billion.

     That disappears under zero bonds and zero rates.

     And as I think you subscribe to the full yield curve effect vis a vis the risk free rate, a corresponding number of some sort gets subtracted from risky bond yields.

     All these fixed income instruments are held by households, pension funds, insurance companies, mutual funds, etc. etc.

     That to me is an agenda.

154. RSJ

     “Well, Greg, historically the bias has been towards inflation, and not deflation.

     But that bias is primarily due to credit growth. It is credit growth that forces the hard powered money to grow. But you are right, the only way to “save” is to dig a hole in the ground, put all the food and clothing you want to consume later into the hole, and then dig it up when you retire.

     Of course, you need to post guards around the hole, pay them, and also rent the hole. And you will find that the goods put into the hole deteriorate with time.

     The only way to get a return is to invest. If you invest, you will get a positive return in a growing economy, but that same mechanism will create inflation that will eat away some of that return. In the end the savers expect magic – they want a credit-based economy that allows them to invest, but they don’t want the inflation generated by credit-growth. They are not happy with the real rate of return, which is positive, at say 3%, but is volatile. They demand the nominal rate of return, or 6%, without the volatility. To them, anything less than the nominal return is robbery, when they should be happy for the real rate of return. That is much better then the alternative, which is to start digging.”

     Thanks for the response and I couldnt agree more. Saving is good, hoarding (which is what too many savers end up doing) is bad.

     The deflationary bias I was referring to is at present. Which of course is exactly when a deflationary bias is destructive (and not creatively so). The low lows end up destroying everything gained (nominally) from the high highs.

155. Anon: That to me is an agenda.”

     I see the agenda as giving 300 billion away as a needless subsidy that is a dead weight better used. Bond issuance is unnecessary under a fiat system, and interest rate setting by a small unelected group that is not accountable is undemocratic and anti-capitalistic.

     It seems to me that the agenda here is solely redistribution.

156. RSJ – The Google Books link of the article you were talking of @ Wednesday, June 16, 2010 at 6:57 is:

     Long Term Interest Rates, Liquidity Preference And Limits Of Central Banking by Mario Seccareccia and Marc Lavoie.

     Quoting a few lines from pages 167, 168:

     In more recent times, however, there are also some heterodox economists who have come to espouse a variant of this approach, which sees the rate or profit as a determining factor behind the long-term rate or interest. Authors such as Wray (1991,1992) express this by saying that the price of short- term bonds relative to that or long-term bonds is an inverse function of the relative proportions in which the public desires them. Therefore, once the monetary authorities determine the returns on the short end of the bond market, market forces would inevitably govern long-term yields via portfolio choice.

     In recent years. Nell (1998, 1999) has further articulated this view. In a nutshell, it is believed that when the rate of growth of the economy is high, so is the rate of profit, in accordance with the well-known Cambridge equation, and hence so will be the long-term rate of interest. Since stock market returns closely follow the vagaries of the profit rates of firms, ultimately the rates of return on the stock market would play a critical role in determining long-term rates of interest. To understand this, let us imagine a state in which the rate or growth of the economy (and therefore, via the Cambridge equation, the rate of profit) exceeds the long-term rate of interest. Since real assets will be compounding faster than financial assets of long-term bondholders, asset owners will be shifting about their Portfolio in favour or holding stocks and away from bonds (Nell, 1999, p. 286). Through the process or capital arbitrage, therefore, prices or long-term bonds would fall, interest rates would rise, which would bring about a gradual restructuring of the yield curve in favour of higher long-term yields. Conversely, in a state in which the rate of growth (and rate of profit) is below the current long-term yield, there would be a movement away from real assets and towards financial holdings. As a result prices of long-term securities would rise and long-term interest rates would fall. Once again. through a process of capital arbitrage, movements in the economy-wide rate of profit (as reflected in variations in the economy’s rate of growth) would ultimately bring about a concomitant movement in long-term interest rates. In this case, much like previous Wicksellian analytics, the governing rate or center of gravitation is the rate of profit or rate of return on stocks while the long-term rate of interest would follow with a lag the movement of the rate of profit through capital arbitrage.

     Unfortunately I cant view all the pages on Google Books 🙁

157. Ramanan,

     One point of clarification regarding the main issue (about the CB control of ST rates) of the article you quote above. In case there is confusion,its results do not prove that CB policy on the ST rate can control the LT rate. Certainly it can influence it but not control it. Even the Granger causality tests do not violate this position.

158. RSJ,

     Here is another Google books link: Transformational Growth, Interest Rates and the Golden Rule by Marc Lavoie, Gabriel Rodriguez and Mario Seccareccia. Google books allows viewing all pages (-:

     Panayotis,

     While I actually do not believe that the long term rate is some expected short term rates, I believe that it does not control the government bond yields, though the central bank may do that in some not-so-limited ways by maturity composition. When I make statements such as it can be made exogenous, I mean it can be made by brute force – only for government bonds, but thats a slightly different topic. Of course, I do not really believe in the “expected central bank reaction function” theory because the central bank doesn’t know its future path either – one can’t predict the future.

159. Ramanan,

     I am in sympathy of the distributional view of interest rates as some of the PK paradigm. However, Moore has a point when we consider the reality of what the CB does even if not successful if we want to analyse MP.

160. ON GROWTH AND LONG TERM RATES

     In my work I have developed the hypothesis that the growth rate of GDP has a dynamic feedback effect upon the risk component of LT rates and in particular it reduces the expected shortfall given default of LT securities. Actually, sometime ago I presented a simplified equation in a comment in Billyblog. In summary, this is the product of duration, the probability of default and a shortfall feedback equation adgusted by the change in the growth rate. The probability of default is calibrated to incorporate terms such as a mean rate subject to a Poisson process, a Brownian motion random step function as an exponential process and a random jump term as an asymptotic hyperbolic function subject to a Pareto process. Thus growth can influence negatively even the risk premium component of LT rates, especially the tail end of this risk, maintaining or even rising any spread between the two. Actually, it can also shift the slope of the yield curve.

161. P — to the degree that one models returns, or human behavior, with mathematic functions, then they are working with toy models. The goal is not to have “realistic” assumptions, but plausible ones. The fewer assumptions the better, actually. I can address some of the other issues you raised at a later time.

     R — yes, that’s the paper. They apply an HP filter to test golden rule growth rates, IIRC. You cannot claim that the government can control the market price of government bonds but not all other assets. All assets compete and are priced at an indifference level.

     T — the interest income on government bond yields does not increase household net financial assets. The fallacy here is assuming that private sector NFA are the same as household sector NFA. Interest payments on government debt adds/subtracts to the NFA of households only to the degree that the bonds were mispriced. They may be mispriced, but there is no reason to believe that they are consistently undervalued.

     What adds to the household NFA is the increase in demand due to deficit spending. The NPV of these demand boosts increase household net financial assets, regardless of whether that deficit spending is funded by the creation of currency or the creation of bonds.

162. Scott Fullwiler says:
     Now you’re the one who’s misunderstood. The desire to expand nets to zero in terms of assets and liabilities on the non-govt sector’s balance sheet. The non-govt sector’s desire to net save shows up as a deficit for the govt sector. This is the difference between horizontal and vertical money. Consequently, the desire to “expand” doesn’t necessarily mean that you haven’t net saved.
     But neither does it necessarily mean you have net saved. As I said, it’s a contingency not a condition.

     As for the horizontal v vertical money argument, there is no reason why the money has to be entirely horizontal. There’s a mechanism for a vertical component and it is well used.

     Historically, aside from the 1998-2008 period, which is a clear aberration that is now resulting in the “balance sheet recession” (though the seeds of that period were being sown for a few decades) the non-govt sector in the US had virtually always net saved (aside from a few . Note that this does not mean they don’t expand their balance sheets as you’ve said, but that’s an expansion of the horizontal component of money (and to be more specific, within the non-govt sector, the firm sector does procyclically move between net deficits (expansion, as you note) and net saving during recessions, whereas the household sector would always be net saving prior to 1998).
     And as house prices continue to rise, the 1998-2008 situation is likely to become more prevalent.

     Regarding Japan’s yen collapsing with public sector deficits and no external surplus, hasn’t yet happened in the US. Your analysis there is far too simplistic.
     It won’t happen to the US while Dollar hegemony continues. And with the Euro in trouble and the Khaleeji’s implementation delayed several years, America’s currency remains relatively secure. Look at what’s happened to the Pound for a more typical situation.

     Go see Warren’s new video on his site on the fundamentals vs. technicals for fx.
     URL?

     You clearly don’t understand much MMT even as you attempt to critique it (or me)
     What I try to understand is the situation. MMT often helps, but I don’t assume it to always be correct.

163. RSJ,

     I have indicated in my previous comments on imperfection and complexity and there is also a lot of math behind this that simplified and non realistic assumptions lead to erroneous analysis. One has to be careful with the assumptions he makes and the logic he uses. Wait for my next comment on relativity and bifurcation to see how possible is to shift from an equilibrium to multiple ones and instability. So be careful with “toy” models they can be hazardous to your health.

164. I agree that you need to be careful with toy models, P, but every model you espoused is equally a toy model. Any model that tries to capture human behavior with mathematical equations falls into this category. Nevertheless, we press on, because we do observe patterns, constraints, and we need some basis on which to make policy recommendations other than partial equilibrium reasoning. And there is nothing wrong with building on the features of models to incorporate additional effects — but you need to persuasively argue that the added complications reverse or significantly alter the conclusions of the model in a meaningful way — not that they just add complexity. It is not enough to argue that you can derive some complicated effect with more complicated assumptions. You need to argue that the same effect cannot be captured with simpler assumptions, and that the effect actually occurs as predicted. Even then, the odds that your assumptions are really necessary to capture the gross movements that we see are unlikely — that’s a very high bar that you need to pass, P, because the economy is filled with noise that wont be captured by any model.

     In regards to order of financing — for legal, logical, and operational reasons, equity must preceed bond financing. When a firm sells bonds, the money comes out of a reduction in equity — the firm is shifting its capital structure. Each individual can of course borrow to purchase equity from someone else, but from the point of view of the firm, it is financed with equity first. There must be an owner who can agree to assume the debt obligation. I think the existing models go wrong in just talking of “bonds” in their models — if you have only one instrument, then it must be equity. If you have two, the second can be a bond, but again the enterprise value will be unchanged when the firm sells bonds.

     If the standard econ models took account of this, they would not have a transversality condition in which the net present value of financial assets goes to zero, because the enterprise value will not go to zero — it will grow with the size of the capital stock, and will always be greater than the size of the capital stock.

     Of course, in the real world, the majority of capital has no access to the bond markets, and only the top 100 or so firms account for the vast majority of all non-financial domestic bond issuance in the U.S. — and we have the deepest bond markets in the world. Nevertheless, only large, mature firms with proven cash-flows can access these markets. Prior to that access, they are funded with equity. I think 80% of U.S. non-financial corporate investment is funded with equity, and pretty much all of non-corporate investment is as well. Once you start talking about the rest of the world, the bond markets get very thin very fast.