So why not use easy money all the time?
Paul Krugman writes about QE and easy money as being beneficial for the bulk of Americans. But he gives reasons that could justify using easy money all the time, even in healthy business cycles.
“The bottom three-quarters of the wealth distribution basically has no investment income.”
This fact applies all the time in the economy… So why not use easy money all the time? We should just make easy money the accepted monetary policy.
Krugman will not see this issue as I see it because he sees the Fed rate stuck at the ZLB due to a large spare capacity. Even if he does not see large spare capacity, he wants to try to push monetary policy past the natural full employment level to generate some wage and price inflation.
But I see very little spare capacity left. In that sense, the capital markets should have been disciplined more. Keynes recognized that keeping interest rates low could sustain a boom, but he also warned that higher rates would be more socially beneficial after all was said and done in a business cycle…
“… it is, I think, arguable that a more advantageous average state of expectation might result from a banking policy which always nipped in the bud an incipient boom by a rate of interest high enough to deter even the most misguided optimists. The disappointment of expectation, characteristic of the slump, may lead to so much loss and waste that the average level of useful investment might be higher if a deterrent is applied.” Keynes
We could say that easy money makes everyone’s life better, so why not use it all the time? Well, the real issue is creating an environment for a higher level of productive investment. Brad DeLong is writing about this now… He wants to know to what extent profits are being enjoyed as rents as opposed to productive investment that benefits workers too.
“What I would like to see Emmanuel and Gabriel guess is the share of wealth that is productive–that boosts the productivity of the working class and that shares those productivity benefits with workers–and the share of wealth that is extractive–that are pure claims on income rather than useful instruments of production, and thus that erode rather than boost the incomes of others.” Brad DeLong
If easy money is encouraging an environment that raises the share of wealth that is extractive, then easy money is not beneficial to the working class.
Monetary policy must discipline the capitalists with a policy tight enough to raise the “level of useful investment” as Keynes puts it. In this light, easy money may not be helping the working class.
What is need is tax policy that does not reward any company that only product is speculation or rent extraction.
You should read that other Krugman post where he talks about the different policy implications of their being a constraint on the supply side of the economy or on the demand side.
I don’t understand why you keep mixing these two things up (hint – your Effective Demand constraint is a DEMAND side constraint).
P.S. Regarding rent extraction and productive investment – I don’t think the level of interest rates play a big role. Things like the level of taxes (taxes come in the end mostly out of rents), the structure of taxes, the average level of private indebtedness, the micro-economic structure of markets and real exchange rates are more important.
Keep in mind the global impact of countries like China that have financial repression. They keep interest rates low … so as to transfer economic advantage from savers to borrowers. They are building a country fast.
The US has to compete with China for investment opportunities, so the borrowing costs are lowered here. But there still isn’t as much growth opportunity as in other countries. So even though interest rates are low, productive investment is low.
But China will run into a big problem with years of low interest rates, and the US will too. Inefficiencies in investment accumulate from rates that are too low. and then you combine this with an investment culture which looks for the quick profit, and you see more speculative investment, or the so-called extractive investment. The key is make sure that investments are productive, not speculative. The key to this is to have higher interest rates. Then investment is pushed into areas that will actually create a larger return, not just playing with asset prices.
China is running into this problem of inefficient investments over the years.
Are we sure there is a lot of bad investment going on? Aren’t firms hoarding cash, doing stock buybacks instead of investing.
Low rates make it so non-established firms can easily invest more and most productivity growth comes from new firms replacing old unproductive ones. Increased rates could cut off growth of new firms while not hampering old firms investment because they have lots of cash and don’t need low rates to invest.
” Inefficiencies in investment accumulate from rates that are too low. ”
Why do you think this? I know Austrians assert this, but the logic seems a bit fetched to me. The danger is not that we invest too much (what does that even mean) but that we run into supply constraints and end up with accelerating inflation. No sign of that.
In my view, productivity is constrained by effective demand. Thus the economy could not increase productivity at the moment. So there are dynamics that block new productive firms from replacing low productive firms. You might see new productive firms starting and doing well, but you will not see productivity in the aggregate increase because other firms will have to reduce their productivity as a consequence of being against the effective demand limit.
Thus there are pressures against the effective demand limit as new productive firms put pressure on lower productive firms. That pressure creates instabilities in the market. Eventually the lower productive firms progressively collapse. Then you get your recession…
Look at the work of Michael Pettis on China. He is definitely not an Austrian, but he shows that low rates in the financial repression of China has created massive inefficiencies in investment. Do you think that investment opportunities in China have not affected the efficiency of investments in the US? Investment opportunities in China have looked really good. So here in the US, firms must present a rosy picture of returns to compete with the financial repression opportunities in China.
quote from Michael Pettis…
“Third, when China desperately needed investment early in its growth period, this growth in economic activity represented real growth in wealth. But low interest rates, along with the moral hazard created by implicit guarantee of nearly all approved lending, led almost inevitably to a collapse in investment discipline. Financial repression has been the main explanation for the enormous misallocation of capital spending we have seen in China during the past decade.”