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The way to reduce the shortage of oil in Venezuela is well known- increase the price of gas.

So does this mean you think that increasing interest rates (ie the price of money) would help alleviate the shortage?

Can't we think of (2) as pushing down the natural (safe) interest rate? Then (1) and (2) both hold simultaneously.

Incidentally, effect (2) should involve an increased spread between safe and risky interest rates. Looking at, say, Corporate bond spreads, we see a marked increase in spreads in 2008 -2009, but none thereafter:
https://research.stlouisfed.org/fred2/graph/fredgraph.png?g=2cDI

Admittedly measuring risk spreads is a little tricky, because there isn't a single "risky" interest rate to look at, and the effect could work through a change in the composition of borrowers towards riskier categories of loans, rather than higher interest rates on a particular category of loan. Nevertheless, whatever this measure was picking up in 2008 - 2009 doesn't show up thereafter.

bacon: "So does this mean you think that increasing interest rates (ie the price of money) would help alleviate the shortage?"

Interest rates are not the price of (buying) money. They are the price of *borrowing* (money). But yes, though we have to read this as: *doing something that would cause* equilibrium interest rates to rise. E.g. raise the NGDP growth rate. Simply telling the CB to "raise interest rates" would make things worse, because they would do that by reducing the nominal supply of money.

jonathan: "Can't we think of (2) as pushing down the natural (safe) interest rate? Then (1) and (2) both hold simultaneously."

I find it more useful to define the "natural rate of interest" as the equilibrium interest rate if output were at the natural rate ("potential"). Otherwise, yes.

Yes, risk spreads are tricky, if some people stop borrowing or lending to each other because of increased risk. But I think we should focus more on "shortages" of money when you try to *buy* it, not borrow it.

@ Nick

Introductory macro tells us in the case of a shortage buyers will bid up prices absent a price ceiling. If the problems in the economy are caused by a chronic shortage of liquidity then interest rates should be rising in response. Thus we should assume (barring overwhelming evidence to the contrary) that the supply issues are due to an artificial price ceiling. As there is currently one organization in the US that has the power to and is actively engaged in setting interest rates, the conclusion from this line of reasoning is obvious.

@ nick

If there are a million loaves of bread in a grocery store and only one person running a register, lowering the total loaves of bread by 500,000 won't impact the number of loaves of bread that hit the market.

bacon: suppose there were two ways to get oil: buy oil; borrow oil. The trouble with borrowing oil is that you need to pay it back. And if you are not sure you will be able to buy oil when you want to pay it back, you won't want to borrow oil, even if you can. So the premium for borrowing oil may fall. The price ceiling in question is the price for buying oil. Aka sticky prices, not sticky interest rates.

@ nick

If that scenario was the case two things would have to happen- one is that futures in oil would disconnect from current prices. We see no evidence of this at all with interest rates. Two is that as stockpiles of oil doubled, tripled and quadrupled this fear would subside.

Lastly if there was a concern about the future supply of oil the WORST thing you could do would be to make storage of oil more expensive, which would exacerbate fears about future supply. Thus charging negative rates on reserves would be among the worst ideas possible.

Nick I know you don't usually go politics but I'm at the edge of my seat: what do you have to say about the Liberals' win? Was it because they promised to run a mild deficit or in spite of?

I looked at the question myself yesterday.

https://lastmenandovermen.blogspot.com/2015/10/is-victory-of-canadas-liberals-because.html

"And because people can't be sure they can easily buy money, they will tend to want to hoard more than they usually would, and be less willing to sell it. Which makes it harder for other people to buy money."

I don't understand. Why would people hoard money that will be half as valuable tomorrow?

Defining liquidity as; the ease with which you can get a loan, as you do in your introduction seems daft.. Liquidity has nothing to do with borrowing it has to do with the ease of turning into cash. I don't have a liquid asset so I can turn it into a loan I have a liquid asset so I don't need to borrow from anyone. The more liquid an asset the more cash like and less loan (or credit like) it is.

In response to your first answer to bacon though, interest rates are the cost of buying money. A loan has a cost and that is the interest rate. When I buy a car through GM financing I m buying their money for a fee which varies based on my credit rating and down payment. Money is a means of settlement and sometimes you have to pay for ( aka buy ) it because you don't have it all at the time of transaction.

Gizzard,

"Defining liquidity as; the ease with which you can get a loan, as you do in your introduction seems daft.. Liquidity has nothing to do with borrowing it has to do with the ease of turning into cash."

Think about collateralized loans. One risk associated with a loan against collateral is the liquidity of the underlying collateral. Market price volatility is another risk associated with collateral.

It really doesn't matter who is able to turn an asset into cash - either me by selling the asset, or my bank by selling the asset if I default on a loan against it.

That is true Frank, but the point is liquidity is about turning into cash or degree of cash equivalency. Yes that "cash" CAN be used as collateral for loan but that is another point entirely. This is about the basic definition. I think Nick is playing very loose with the term. Most people would prefer NOT to borrow and having a very liquid asset means you can use it instead of borrowing.

Saying "a liquid asset makes better loan collateral than an illiquid one" would be inarguable but he went further than that.

RN: "I don't understand. Why would people hoard money that will be half as valuable tomorrow?"

They wouldn't. People won't hoard money in a hyperinflation. But they would hoard money in a recession. I am contrasting two very different types of "shortage".

Gizzard,

"Most people would prefer NOT to borrow and having a very liquid asset means you can use it instead of borrowing."

That would depend on the price volatility of the asset. Just because an asset is very liquid does not mean that it's price / value is stable across time. Currency (as an asset) is both very liquid and is stable across time (a $1 bill today will buy a $1 bill 10 years from now).

And so a person may want to borrow against a liquid but volatile asset as a risk management tool. In this way, price volatility risk is passed onto the lender as long as the terms of the debt contract limit the lender to being able to retain the collateral and not seeking additional payments.

"And so a person may want to borrow against a liquid but volatile asset as a risk management tool."

Instead of just selling it?! Why on earth would someone choose to borrow against something rather than sell it? If its liquid that means its easy to sell.

Say I have a stock of volatile value but there is an exchange where I can sell it easily. Why would I use that stock to borrow against and incur interest expenses as opposed to just selling it? There is no way a lending institution will give me better terms than an exchange. No bank will lend me MORE than the asset is worth on an exchange. In fact they will lend me less so if I default they have built in some profit off the collateral.

"Instead of just selling it?! Why on earth would someone choose to borrow against something rather than sell it?"

Because a person may eventually want that liquid asset back. Liquidity may not be the only reason the person owns that particular asset.

If the person sells the asset and then wants to buy it back later he / she is taking price risk. If he / she borrows against the asset, then the lender is taking price risk.

Frank,

You are talking about situations that are quite on the margins of economic activity, not within the behavior of most economic actors. Yes at the financial institution level many assets are used as collateral to obtain others for short periods of time and risk premiums/market prices are determinants of short term gains/losses. Often in these situations their is an intent to use and not sell the financial asset. But this is not how most economic activity is undertaken. The average guy trying to squeeze more spending power out of their income does not operate in the way you describe. If I need to come up with 5000$ to buy something and I have a stock worth 5000$ that I can trade easily (very liquid) I am going to sell the stock and use the money not take the stock to a bank and borrow against it. The loan will cost me more than 5000 and Id be a fool to do that, not to mention the bank won't lend me the full 5000 they will take the stock and lend me 4500 so they have some default risk coverage.

Gizzard,

You asked - "Why on earth would someone choose to borrow against something rather than sell it?"
I answered - "Because a person may eventually want that liquid asset back....If he / she borrows against the asset, then the lender is taking price risk."

You answered - "If I need to come up with 5000$ to buy something and I have a stock worth 5000$ that I can trade easily (very liquid) I am going to sell the stock and use the money"

And my answer is - And after you get that $5000, you will never buy stock again for the rest of your life? What is the point of selling the $5000 in stock only to buy stock at some later point in time?

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