Negative interest rates
[Still on the quick-and-dirty posting jag, but I am not very good at it.]
I've also been reading apocalyptic stuff from economics people, largely about negative interest rates. Not only are many central bank rates negative, many sovereign debt bond yields are negative out to five years or beyond. This is completely and utterly bonkers, which is terrifying.
For clarity: Normally, when you borrow money from someone, you have to pay it back plus a bit extra - the interest - for the privilege. With negative interest rates, you borrow money from someone, and you pay back *less* than you borrowed in the first place. You get free money for having borrowed money. There was a theory that this meant that interest rates could never be negative. Hence the "zero lower bound". Why would anyone lend money if they were guaranteed to get less of it back?
Well, that theory is empirically blown clear out of the water by the fact that people with lots of money are queuing up to lend money to several Governments despite the fact that the Governments are promising to pay less back than they are being lent.
This is a terrible, no good, very bad sign. Even worse, we are starting to worry that low or negative interest rates are having the opposite effect to what basic, obvious, nuts-and-bolts macroeconomics 101 says.
I've whined about this before. The basic idea is that if there is too little inflation, the money supply is too low, so the central bank should lower interest rates, which will increase the money supply and boost inflation
But this doesn't appear to be happening.
I've seen many arguments for how this happens, but one has suddenly hit home as very compelling.
With short-term low interest rates, people move consumption forward: if it costs almost nothing to borrow the money, why not buy the thing you want now and have it earlier for free? On the margin, people save less and spend more. Thus consumption increases, the velocity of money goes up, and there's a bit of inflationary pressure.
But once interest rates look set low, a different effect comes in to play. People who know they are going to want money later start to worry that they need to put more by in order to have enough, and so cut back on consumption and save more. Savings increase, consumption decreases, the velocity of money goes down, and there's a bit of deflationary pressure. Oops.
Who are the people who know they are going to want money later? Well, it includes working age people who plan to retire at some point. Because interest rates are low and seem stuck down there, you need to build up way more of a pension pot to have the same comfort in retirement. Your money grows much less over your working life: £100 invested at 4.5% for 25 years gives you £300 at the end, but £100 invested at 0.25% for 25 years only gives you £106. And then once you come to cash in your pension pot, annuity rates are very, very low so you need a much bigger pension pot to get the same income.
(There are other groups of people who know they will want money later, notably those who want to buy a house at some time. But house prices are so completely bonkers at the moment I'm leaving them well out of this discussion.)
This argument hit home as compelling because it describes my experience. When interest rates first collapsed, I was delighted, because it meant my mortgage payments fell through the floor. When they looked here for a little while, I decided to do the extension to the house before we were absolutely bursting at the seams, rather than waiting. But now they are stuck flat for a long time, it's hit my pension, and I've had a long hard look at how much I need to put by and decided it really could do with being more. I'm also increasingly worried about how the kids will ever make their way in the world without a substantial financial leg up to start with, which also makes me want to save as much of my income as I can.
So I'm finding the argument that prolonged low interest rates serve, somewhat paradoxically, to reduce consumption and increase saving oddly compelling.
This entry crossposted to http://doug.dreamwidth.org/307347.html, where there are
comment(s) not shown here.
I've also been reading apocalyptic stuff from economics people, largely about negative interest rates. Not only are many central bank rates negative, many sovereign debt bond yields are negative out to five years or beyond. This is completely and utterly bonkers, which is terrifying.
For clarity: Normally, when you borrow money from someone, you have to pay it back plus a bit extra - the interest - for the privilege. With negative interest rates, you borrow money from someone, and you pay back *less* than you borrowed in the first place. You get free money for having borrowed money. There was a theory that this meant that interest rates could never be negative. Hence the "zero lower bound". Why would anyone lend money if they were guaranteed to get less of it back?
Well, that theory is empirically blown clear out of the water by the fact that people with lots of money are queuing up to lend money to several Governments despite the fact that the Governments are promising to pay less back than they are being lent.
This is a terrible, no good, very bad sign. Even worse, we are starting to worry that low or negative interest rates are having the opposite effect to what basic, obvious, nuts-and-bolts macroeconomics 101 says.
I've whined about this before. The basic idea is that if there is too little inflation, the money supply is too low, so the central bank should lower interest rates, which will increase the money supply and boost inflation
But this doesn't appear to be happening.
I've seen many arguments for how this happens, but one has suddenly hit home as very compelling.
With short-term low interest rates, people move consumption forward: if it costs almost nothing to borrow the money, why not buy the thing you want now and have it earlier for free? On the margin, people save less and spend more. Thus consumption increases, the velocity of money goes up, and there's a bit of inflationary pressure.
But once interest rates look set low, a different effect comes in to play. People who know they are going to want money later start to worry that they need to put more by in order to have enough, and so cut back on consumption and save more. Savings increase, consumption decreases, the velocity of money goes down, and there's a bit of deflationary pressure. Oops.
Who are the people who know they are going to want money later? Well, it includes working age people who plan to retire at some point. Because interest rates are low and seem stuck down there, you need to build up way more of a pension pot to have the same comfort in retirement. Your money grows much less over your working life: £100 invested at 4.5% for 25 years gives you £300 at the end, but £100 invested at 0.25% for 25 years only gives you £106. And then once you come to cash in your pension pot, annuity rates are very, very low so you need a much bigger pension pot to get the same income.
(There are other groups of people who know they will want money later, notably those who want to buy a house at some time. But house prices are so completely bonkers at the moment I'm leaving them well out of this discussion.)
This argument hit home as compelling because it describes my experience. When interest rates first collapsed, I was delighted, because it meant my mortgage payments fell through the floor. When they looked here for a little while, I decided to do the extension to the house before we were absolutely bursting at the seams, rather than waiting. But now they are stuck flat for a long time, it's hit my pension, and I've had a long hard look at how much I need to put by and decided it really could do with being more. I'm also increasingly worried about how the kids will ever make their way in the world without a substantial financial leg up to start with, which also makes me want to save as much of my income as I can.
So I'm finding the argument that prolonged low interest rates serve, somewhat paradoxically, to reduce consumption and increase saving oddly compelling.
This entry crossposted to http://doug.dreamwidth.org/307347.html, where there are
comment(s) not shown here.