Down with r!… Up with the Fed rate!… yells a protestor
Thomas Piketty’s Capital in the 21st Century shows us where society is going. Paul Krugman summarizes this future using Piketty’s term, Patrimonial Capitalism, where inherited wealth gains economic power and where hard work returns less money than inheritance.
The basic equation underlying patrimonial capitalism is… r – g.
r is the investment return to capital. g is economic growth. As David Cay Johnston points out…
“When investment returns exceed economic growth, the rich get richer, increasing inequality.”
“When an economy grows at 1 percent annually but investment returns are 5 percent, the already wealthy need to reinvest only a fifth of their gains for their fortunes to grow at the same rate as the overall economy. The rest can be spent on a sumptuous lifestyle.”
So any protestor from the middle and lower incomes should be yelling… Down with r!
As a society we should be fighting against this push into patrimonial capitalism by the rich. We should be calling for policy to reduce the returns to capital investment. We should be raising taxes on the wealthy. And we should be raising the cost of capital funds, which would mean a higher Fed funds rate.
Yet the Fed plans to keep the Fed rate low for a long time. Even when the Fed rate should be 4% at full employment, it seems as though the Fed projects a 2% Fed rate. Thus the Fed will keep the cost of capital funding artificially low for God knows how long. The middle and lower incomes in the US, Europe and elsewhere are doomed.
The more the Fed rate stays artificially low, the more patrimonial capitalism will grow. We are doomed.
And the worst thing is that economists like Paul Krugman are pushing to keep the Fed rate low. It is the greatest twist of economic logic into economic illogic. Progressive economists lack a vision of what their proposed policies are actually doing to the economy and society. They are not understanding the intricacies of their medicine. And things are getting worse.
The traditional doctors of Tibet said that every substance is either a poison or a medicine. Treating disease with any substance depends on how the substance is used and how much is used. In a narrow-minded perception, the low Fed rate should be a medicine for an economy with high unemployment and great spare capacity. But when that spare capacity is already limited by weak effective demand, the costs of the medicine will outweigh its already limited benefits. The medicine becomes not just ineffective, but poisonous in the midst of other policies that increase r (investment returns to capital). The imbalance of inequality grows. Labor’s economic power shrinks. Labor share falls. Patrimonial capitalism increases.
Just as Mr. Johnston points out above, capital need invest less of its returns to grow the economy, while they enjoy higher rents and higher rates of return. Let’s take a moment to remember that aggregate profit rates are very high by historical standards. Effective demand becomes weaker as labor share falls.
When will progressive economists wake up and realize that they are mis-prescribing a medicine when they call for long-term loose monetary policy? The medicine is a poison for society considering the new dynamics of the current economic disease.
Capital has less incentive to value labor. Hard work does not pay. The transmission mechanisms of Fed policy to labor have broken down. As Mr Johnston wrote…
“Balzac, who famously wrote that “behind every fortune lies a great crime,” lived in a world the vast majority of us would not want to see recur, a world in which merit and hard work mattered little.
“Piketty argues that we are headed back in that direction, however, through misguided government policies that encourage dynastic wealth and favor returns to capital over income from labor. His dark vision is one in which even the strivers will have a tougher time, and more modest fortunes, than those whose primary basis for their riches is ancestry.”
Down with r!… and Up with the Fed rate!
Let’s get tough on these patrimonial capitalists.
Don’t confuse debtors with the wealthy or creditors with the poor.
“When investment returns exceed economic growth, the rich get richer, increasing inequality.”
That inequality can make the poor richer.
For example, say, the U.S. offshored all its old manufacturing industries, imported those goods at lower prices and higher profits, and then employed those profits in emerging industries with market power to export, improving its “terms-of-trade.”
U.S. workers earn higher real wages in those new industries, the creation of capital allows more investment, and the U.S. is able to exchange fewer domestic goods for more foreign goods.
Over time, those new industries become more efficient, redeploying limited resources to produce more output with fewer inputs.
There’s a low g and a high r, because of huge U.S. current account deficits and capital account surpluses, while government maintains anti-g policies slowing the economy and keeping unemployment too high.
And, the federal anti-g policies come from politicians/lawyers in Washington, not the Fed.
Here’s what Bob Brinker said about the Fed (Dec 2012). I completely agree with him:
“It’s only because the Federal Reserve has been active that we have any growth at all in the economy….The Federal Reserve is the only operation in Washington doing its job.
The only person that would criticize Ben Bernanke would be a person who is so clueless about monetary policy and (the) role of the Federal Reserve as to have nothing better than the lowest possible education on the subject of economics….Anybody going after Ben Bernanke is a certified, documented fool….”
Call me a fool, but isn’t Ben a Goldman-Sachs alumnus? ANY fool that doesn’t question The Fed for the last 2 decades and its leadership is a sucker.
Should have let 2big2fail go ahead and die by The Invisible Hand Of The Free Market around their throats. Ya know how that BANKER WELFARE teaches them to not work.
The relevant dynamics are between capital income and labor income.
DeLong says :
“…I would point to 2005-8 as evidence that we are not doomed: that the economy could have, and can still, rebalance itself at (what we used to think of as) full employment…”
So , I guess he thinks we’re due for another debt binge. It’s depressing , we’re 5 years into this and economists are just spinning their wheels.
Making it even worse is that DeLong writes from the ” Washington Center for Equitable Growth “.
You’d think he might take the hint…….
Thanks for the link. I share your disgust with the idea of more debt but if we want to generate more debt then let’s do it with some real gusto. Let’s raise everyones credit score to 800. (By economic policy or law) This should work since we don’t seem to believe that excessive indebtedness is a problem anyway.
In Marko’s link:
Brad DeLong (March 24, 2014):
“And while I will not say that Say’s Law is true in theory, I will say that the panoply of economic policy provides plenty of weapons to make it true in practice…”
I read your post on 12-29-2013: http://effectivedemand.typepad.com/ed/2013/12/says-law-fairy-build-it-and-they-will-come.html
But I did not fully appreciate why you were discussing Say’s law. I am beginning to appreciate it more as I read the comments to your various posts here.
When did we stop believing that individual consumers should drive the economy and not economic policy? Didn’t the Soviet Union prove beyond any serious doubt that the mere production of a poorly styled and cheaply made product would not create demand for it? When consumers were no longer forced to buy the product, production ceased. Would continued production of that product have benefitted anyone beyond the current weeks pay to produce it?
Have economists redefined the word ‘demand’ so that it no longer retains it’s common meaning? Has it become an example of Newspeak?
Perhaps nothing can change until Say is burned in effigy, over and over again.
It is payments that are important, not debt. Most of our personal debt is in mortgages. There is absolutely no difference in the financial stability of a person paying 28% of his income on his mortgage with a payment of $1984 at 7% and owing $300,000 than there is of a person paying 28% of his income on his mortgage at 4.5% with the same payment and owing $393,000.
It is all about getting income to the bottom 90%.
Say’s law is important because it assumes that if monetary policy stays loose, unemployment will keep dropping and output will keep rising.
Many progressive economists believe this by promoting a low Fed rate far into the future that will take us back to a previous full employment.
However, Keynes pointed out that when there is weak effective demand, the economy will fall short of full employment. Effective demand is very weak since the crisis due to labor share falling so much.
A strange creature The Economist
In the land of supply and demand
He sees neither The Salesman
Nor The Guy With Cash In Hand
Your Piketty post got a mention in DeLong’s summary of reviews :
Thanks for pointing that out. I hadn’t seen it.
I don’t get it. If you raise the Fed Funds rate this increases the interest income the wealthy receive on their financial assets, whilst debtors with mortgages and loans have to pay more of their income to the wealthy creditors. How does this reduce inequality?
There is damage occurring from increasing inequality.
Let’s follow your logic… if you raise the Fed funds rate, this increases the interest income to the wealthy on financial assets. Stop right there… What would happen to stock prices? What would happen to bond prices? What would happen to government debt service? What would happen to housing prices? What would happen to the possibility of a bubble? What would happen to aggregate profit rates? What would happen to the movement of international capital? What would happen to businesses that rely on low wages and low interest rates to survive?
Let me summarize the answer for the above… the effect is to clean out socially wasteful economics.
Think of grades in a university. The purpose of grades is to show who is a more capable student. But if the standards on grades falls apart, and poor students start getting good grades, how do you know a good student from a bad student. They both end up getting equal chances for employment. Yet, by your logic, if the grades were tightened again, some students would be less employable, while some students gain an advantage. but the point is that the good students should gain an advantage and the grades have to be tight to accomplish that.
Many factors need to be tightened, not only the Fed rate. The economic standards of a good balanced economy need to be raised again in many areas. Free market processes have eroded these institutional standards.
We cannot just look at how a rise in the Fed rate would effect creditors and debtors. We also have to look at the quality of those relationships. What investments are socially beneficial and what investments are privately beneficial. We have to look at the institutions within which they function. In the final accounting we have to look at private costs and benefits compared to social costs and benefits.