The following comment was posted on the blog last night. The person posting it used what was, very obviously, a false name and email address and I would normally have deleted it. However, whoever the troll might be they raise points that reflect real economic confusion, and for that reason I thought it might be worth addressing the question that they posed. This is what they asked:
I must admit I don't understand your criticism of positive interest real rates – surely if we want corporations and individuals to invest and grow the economy, they need to achieve a return ahead of inflation, otherwise they are net worse off?
Why do you want to discourage investment AND make people worse off? What have I missed?
This person has made a number of false assumptions.
Most fundamentally this person has made the mistake of assuming that people who save in cash want to invest and grow the economy. That is not true. People save in cash accounts because they wish for financial security, and to get their money back. The essence of cash-based saving is to seek security. As a consequence, the last thing that those who save in this way want is that their money be put at risk.
Investing to grow the economy does, inevitably, require that risk be taken. The goal of this activity is to make a profit. The pursuit of profit is an inevitably uncertain activity. It is undertaken by those who want to take a risk. They are willing to face the possibility that they might get less than they saved back, or nothing at all.
The return to the person who saves to invest in growing the economy is, then, fundamentally different from the return paid to the person who saves in cash, whose sole goal is to set their money aside for future use with minimal risk arising in the intervening period. One gets a return, which is a share of profit, which is called a dividend, and the other is paid interest.
A dividend is paid because a profit has been earned, which is an uncertain outcome. Interest is paid because of the passing of time, which is a certain outcome. The first involves risk. The second involves very little risk. This is the first, and fundamental, difference between the two.
The second fundamental difference is the way in which the funds are used. The funds intended to grow the economy have to be invested in a very particular way. A person investing in this way has to either become a partner in a business, and so accept the unlimited liability consequences of doing so, or buy new shares issued by a company that is seeking to raise capital to invest in its growth, and so in the growth of the economy.
LAs a matter of fact, very few people commit any serious funds to the first of these activities. Most partnership businesses in the UK have very low capital intensity, and are largely engaged in the supply of services. When significant capital is involved very few people wish for the risk of unlimited liability. In that case, we can pretty much dismiss this option.
The flow of significant capital funds into new share capital in the UK is also very small. New share capital issues by quoted companies are rare. Those that do take place are usually associated with merger and acquisition activity, or the original placement of shares on a stock exchange, and neither usually provides funds for growth or investment, but do instead replace existing owners with new ones. The vast majority of small companies have tiny share capitals in proportion to their funding requirements. Those companies that fall between groups are either funded by private individuals, who are called angel investors, or by venture capital funds. However, together, they represent a very small proportion of the UK savings market. In other words, this type of saving activity is notable by its scarcity.
Saying this, I do not deny that people save in shares. As a matter of fact, they do. However, the vast majority of people who do so are not providing funds to promote investment in, or the growth of, the economy. Instead they acquire secondhand shares on the stock exchange, i.e. they buy shares previously issued by a company that are now owned by a third-party who is entirely unrelated to it, which that third-party now wishes to make available for sale. The company that originally issued this share gets precisely no benefit from its sale, whatsoever. As importantly, not a single penny of the money saved in this way is, as a result, used to invest in or grow the economy. All that actually happens is that a gamble is made on the future direction of the value of the shares of the company that have been acquired.
Importantly, that change in the value of the shares in question may also have nothing whatsoever to do with the generation of a return on investment. Fashion and whim, plus irrational sentiment, are as likely to impact this. For example, almost all the gains arising on stock exchanges at present are attributable to a very few, very large, tech companies. It is presumed that these will become very much more profitable because of AI, but no one really knows if this is true, or how it might happen. That increase in value could vapourise as quickly as it has appeared. The point is, this return should not be considered to be related to investment, or growth, let alone to any activity in the trading of the shares of the company in question. And quite emphatically, it has nothing to do with the interest rate.
In fact, the only thing that a high interest rate does is reduce the rate of growth in the economy. There are four reasons.
Firstly, consumers have less to spend on goods and services, meaning that demand within the economy is reduced, as is growth. The higher the real rate of interest, i.e. when adjusted for inflation, the stronger is this effect.
Secondly, the higher the rate of interest, the lower will be the rate of profit within the economy. This is because most companies borrow and the more that they have to pay in interest, the less that there will be available to the shareholders. As a result, the already limited incentives to invest for growth are reduced even further.
Thirdly, this also means that the amount of funds that can be retained by a company for reinvestment within it will be reduced, and this is by far the most common source of investment for growth in the UK economy.
Fourthly, the incentive to take a risk by investing for growth is reduced if a real rate of return is available within the economy by taking no risk it all. Once again, the funds available for investment will fall.
It is, therefore, readily apparent that if growth is to be the objective (and I question that), then positive rates of interest provide a massive disincentive for that to happen.
And all this is, of course, before the social consequences of positive rates of interest are considered. These relate, most especially to the redistribution of wealth upwards within the economy, and the strain placed upon households with regard to housing cost, in particular, so that this upward redistribution of wealth might take place.
Then you have to stand back and realise that all this interest is paid for the use of money which literally costs nothing for a bank to produce, and what you then appreciate is that this whole hierarchy of charging for a wholly artificial commodity created as a human construct to exercise power within an economy is morally repugnant. Hardly surprisingly, the great, wisdom traditions all condemned the charging of interest. They were right to do so. We have, however, let those with power ignore this at cost to all the rest of us. The price for doing so has already been far too high. It looks as if it will get much higher still because the Bank England wants us to have long term high positive interest rates, and that is economic madness.
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Tories in marginal seats are now getting frightened that the strategy of raising the base rate is going to lose them their jobs:-
“Mortgage ‘catastrophe’ will lose us the election, warn Tory MPs”
“People [are] telling me their monthly mortgage payment is exceeding their salary. That is unsustainable.”
https://www.theguardian.com/politics/2023/jun/18/mortgage-catastrophe-will-lose-us-the-election-warn-tory-mp
That has put your correspondent firmly in their place.
The narrowmindedness is also accompanied by the usual boring orthodoxy isn’t it?
The late Richard Douthwaite thought it desirable to have different interest rate levels dependent on where the money was being used in the economy – sectoral interest rates?
So those investing in risky ventures might have (say) a higher rate than domestic users of credit, the use of which is related to wage’s relationship to price inflation.
Just hiking rates across the board actually at then end of the day increases the risk to lenders and borrowers alike.
It’s the most ridiculous thing I’ve ever seen and you and Danny are right to keep pointing it out.
“In fact, the only thing that a high interest rate does is reduce the rate of growth in the economy. There are four reasons.”
This is true, but you fail to say at the same time that the four things you list reduce growth by reducing demand and spending, which has a deflationary or inflation reducing effect on the economy.
But then you also complain that higher rates do nothing to reduce inflation, which is in direct contradiction to the above.
If it is the case that higher interest rates have no effect on inflation, then what would you use to control said inflation?
As well as lower rates I have also seen you argue for increased government spending and even more QE, even currently when inflation and more importantly core inflation is very high.
What do you think the effect of this would be on inflation?
Inflation is a reflection of market conditions
Unlike you, I happen to think markets are, to some degree, self connecting. This is certainly true when it comes to inflation. Inflation is a phenomena of temporary economic disruption, whether to supply lines or the terms of trade (e.g. Brexit). It cannot survive without further disruption e.g, from high interest rates.
So the answer national inflation is to restore economic stability – by reducing rates, allowing exchange rates to float, and by promoting full employment.
Richard,
Inflation is indeed a symptom of economic conditions. In this case, initially there was a price shock (food, fuel, which has subsided now), but also there are inflationary pressures from the vast increase in money supply and low levels of unemployment (which is why core CPI is still rising).
That was not the question I asked though. I asked you if the four points you make regarding interest rates also reduce inflation, which they clearly would do given they suppress demand.
“So the answer national inflation is to restore economic stability – by reducing rates, allowing exchange rates to float, and by promoting full employment. ”
Let me further ask you a question about this statement. What effect do you think lowering rates would have on inflation?
Markets would expect (and immediately price) far higher inflation if you cut rates. The money supply would once again increase, the currency would depreciate importing more inflation and already tight job markets would become further strained leading to an increase in the wage/price spiral we are already seeing.
The only way to reduce inflation is to reduce final demand, yet you seem to be suggesting that we should increase it. Basic economics.
Ian,
“Under proper MMT, there would not have been this level of inflation. ”
No, it would be far worse still. Zero interest rates and even more money printing. Turkey tried almost exactly this, with predictable results.
MMT, already a fringe “theory” before this round of inflation now has seen any credibility totally destroyed. After all, for years various MMT types were telling us we would never see inflation ever again.
That aged well.
There is bit the slightest indication that increased money supply has had any impact on inflation.
And you make three massive further errors. The first is that market expectations really matter. They don’t, because reality would quickly show them to be wrong. Secondly, money supply matters: it doesn’t because you ignore rapidly decking velocity of circulation. Third, MMT never said there will never be inflation. But you never came here to be competent or serious, did you? Nit, come to that, is your name Frazer.
“MMT, already a fringe “theory” before this round of inflation now has seen any credibility totally destroyed”
@Frazier. Sorry, I’m not seeing an economy that looks like MMT. Inflation is due to bad neoclassic economics, but I can see why people would want to blame MMT for their errors.
🙂
“The only way to reduce inflation is to reduce final demand”.
You do not explain what caused inflation. Without an explanation of the problem, what you present is solely an assertion; without any substance, or authority to support it.
What is your explanation? Please provide sources. None of us I supect, quite frankly can afford to waste our time to indulge evidence free assertions by, effectively, an anonymous commenter.
“what would you use to control said inflation”
Under proper MMT, there would not have been this level of inflation. One of the causes is the astronomical increases in energy prices due to supply problems a year ago. Even now, energy prices are being deliberately held artificially high to reap the profits despite low wholesale prices now.
The Green New Deal would have invested in green renewal energy (giving us energy sovereignty), so that the UK is not reliant on external supply problems. See https://greennewdealgroup.org/ It’s also good for the environment and good for UK employment.
Frazer
Your arguments don’t stand up to scrutiny in my view.
For sure there will be genuine inflationary effects caused by the Ukraine and even ships getting stuck in the Suez canal – but these effects never last forever as human ingenuity solves the bottleneck problem and supply chains find a way around it, and inflation drops – as it always does. Humans adapt, and commerce goes on, inflation falls. Sometimes supply chains hobble on, up and down.
That is unless markets and the prime movers in the those markets decide to join in and make the most of the opportunity to make some money – like gas shippers and energy companies. And then you get a mass cashing-in by the markets – from widgets to lawyer’s bills. The herd instinct – that most rational of human behaviors apparently – kicks in doesn’t it and there is a feeding frenzy for which the victims – the consumer, the worker, gets the blame. How predictable you are Frazer!!!!
Which brings me to your comments on wages and low employment that you seem to suggest cause inflation – you give yourself away right there Frazer. You seem to be arguing for unemployment and low wages, and that inflation is a form of punishment for having the alternative. Really?
What an ugly way of thinking. And then you think that you’ve set yourself up for a really clever denigration of MMT at the end.
As Ian has said, MMT has effectively not been used – QE – a more narrow tool – has and where did it go – into the private banking system where it has been used for what exactly? So why mention it except to have a swipe at MMT in the end?
But there is one way of controlling inflation that has not been used yet and that is the use of tax. Here, tax could be increased in some areas (the producer end) and reduced in others (at the consumption end) because you are not just controlling inflation Frazer, you are helping voters to cope with it (had that occurred to you at all old chap? Or is your real name Andrew Bailey by any chance?).
MMT and tax are closely linked. If you are pumping money into an economy, it has to be taken out too. Not taking it out is asking for trouble. All QE did was boost asset prices and the low and no tax regimes for the rich did the rest – it trickles down into the economy and causes inflation that way (trickle down economics works by passing on inflation – not wealth – did you not know that Frazer?). Did Turkey put up its taxes when it printed all that money you said it did? Tax cools the economy and redistributes to those in the supply chains who might be being priced out.
Tax also Frazer might help to deter price gouging in the first place. Why bother if the Government gets it – the prime causes of inflation just might be the too light an application of tax where credit and money are allowed to congregate and be amassed to be released into the economy?
And Frazer – the real reason – the ONLY real reason – we are having interest rate rises is to enable creditors to conveniently dip their noses in the inflation trough and make money themselves on established credit agreements or on credit issued because not even private sector wages are keeping up with inflation.
The whole thing is like watching a school of piranhas reacting to smelling blood in the water – I’m afraid it’s no more intellectual than that Frazer.
That is all you are defending mate. Now, be on your way…………………..
Well said
I noticed this by Andrew Verity. It suggests the Bank of England is quite happy to sacrifice people to protect itself.
https://www.bbc.co.uk/news/business-65916892
“if we want corporations and individuals to invest and grow the economy, they need to achieve a return ahead of inflation”
Reminds me of public sector workers, nearly all of whom have wages whose value has dropped about 20% since 2010, who would also like a return on those wages, but find they can afford less and less. They can’t even “invest” in buying a home because mortgage rates are increasing, and those who have mortgage payments are having to pay more, not because banks MUST increase their repayments, but because the CAN.
No disposable income, no economy.
25% Ian, not 20% – that’s what retirees pensions statements are telling us.
Thank you.
Typo: “the stronger is this affect”. I think you meant ‘effect’.
I do
I dictated that post and remember telling my self to correct that
Oh well….
The other thing I’ve seen mentioned about positive interest rates is to help the bond market and the value of the pound.
I’ve no idea how pandering to either really helps the economy as a whole.
It helps the value of the pound
It also ruins us
Letting the pound fall would be better
A very clear explanation, as ever, of a complex problem.
As a side issue, at what point do we reach “peak financialisation” where all the assets that could be used to derive speculative “investment vehicles” have been used up?
Or do they just go on creating new derivatives from the sad remains of the last crop?
The very worst kind of composting, surely!
I suspect they would create derivatives forever
This is their only interest in green issues
Good blog.
If I may add a practical example: most renewable developers fund projects through a combination of debt and equity. The ratio is typically 80/20 and this seems to apply to both small players (100MW projects) as well as the big off-shore players. Exceptions to this include Shell – which claimed to me (in 2018) that they funded renewables off thier balance sheet. Changes in interest rates will mean more expensive renewable electricity – & given the 4:1 leverage one could expect significant rises – sure enough new German on-shore wind projects have moved from Euro50/MWH (typical in 2019) to Euro60/MWH – now. Similar changes have happened acrosss the EU and UK. Euro & UK serfs will pay for this. Natch.
Gov “interest rates” are wholly synthetic in the level that they take. As I noted in another post, the Chinese seem to have recognised this reality – thus Chinese industries that are seen as strategic are funded at interest rates that reflects their importance. That this does not happen in the EU/UK – where more blunt tools such as “subsidies” are used, is a reflection on the collective imbecility that has a hold on the minds of “western” financiers. Doubtless the Chinese are wetting themselves with laughter.
You may well be right….
Your last paragraph absolutely nails it.
The natural extension to your suggestion that savers shouldn’t expect positive real returns is that they should expect to lose purchasing power, meaning that they’d be incentivised to consume not save.
Which is directly at odds with lots of other things you’ve said.
Many of the comments you make appear to directly contradict each other, for example:
Reducing interest rates will directly reduce the value of our currency and hence increase the value of imported goods and general products (given that energy is typically priced in USD), directly increasing inflation, which is the opposite of what you are trying to achieve.
Please can you explain why this apparent contradiction doesn’t, undermine the point you are making.
I will explain when you can tell me why you were called Sarah Pascoe only this weekend?