Interest rates, asset prices, and the rich

Does anybody here remember 1982? When interest rates went very high, and so asset prices went very low. Just the opposite of today.

What were people saying back then?

1. Were they saying: "Central banks are setting high interest rates and making asset prices low, which is bad for the rich, who own all the assets"?

2. Or were they saying: "Central banks are setting high interest rates, which is good for the rich, who have all the money to lend"?

Because my memory isn't very good. But I thought they were saying the second, back in 1982. And nowadays I think I hear the first, only in reverse.

P.S. And is anyone today writing a book about "saving the hippo"?

P.P.S. Maybe the underlying problem is that many people think about policy actions, when they should be thinking about policy regimes. Thinking about policy regimes imposes a symmetry on our analysis.

Comments

[Rick T.]

Some people are saying now, and would have said in 1982 if they were around then and thought the same way: Whatever interest rate central banks set is the wrong one, unless by pure chance it was the exact same rate that would have come from a free market, in which case, who needs the central banks?

An interest rate, the price of a loan, like the price of any good or service, is not a random number that can be arbitrarily altered with no effect. Prices exist to balance supply and demand, and to send signals to participants as to where capital should be allocated to alleviate imbalances due to too much supply or demand. Any governmental body, such as a central bank, that picks and enforces a certain price for something, will create imbalances of supply and demand, and in effect send false messages to the market as to where capital is needed or not needed.

People responding correctly to what is in fact false information is a major cause behind bubbles and crashes.

I think one reason why some people point out that central banks policies of ~0% for years on end have caused multiple bubbles in speculative assets, benefiting only those who own them, i.e., the rich, is that the people who most adamantly support this central bank interest rate manipulation are the very ones who claim they are doing it to help the poor.

[Nick Rowe]

Rick T: OK. The Austrian perspective. How do you know that 0% isn't the free market interest rate today, and 20% the free market interest rate in 1982? Free market prices fluctuate too.

[Roger Sparks]

Nick,

In '82, when Volcker arrived, an obvious change of philosophy also arrived. Prior to Volcker, a tic in inflation would produce a reaction from the Fed, always a small increase in interest rates (to contain the inflation). The increase was predictable and followed the inflation news. The key word here is "predictable".

Volcker came in with a philosophy of getting AHEAD of inflation. He managed a drastic increase in interest rates, an increase well past the ability of the private market (the borrowing part of the private market) to accommodate. The result was a sharp decrease in borrowing, which resulted in a sharp decrease in financial stimulation, which resulted in a decrease in the number of available jobs, which resulted in a reduction of wage demands from organized labor. Inflation quickly came under control. Unemployment quickly rose.

My observation of this event convinced me that interest rates are controlled by the Central Bank more than any other factor. QE has not changed my mind on this control-of-interest issue.

[Bob Smith]

Are you suggesting a lack of intellectual consistency on the part of certain unnamed opponents of shooting large amphibious mammals?

I think the problem is ex post facto reasoning, coupled with an ideological assumption that everything is done for the benefit of the "rich". People with assets in 1982 or 2010 did well over the next few years (or decades) ergo the monetary policies of the era were designed to benefit them. There's probably truth to the proposition that, in 1982, the wealthy were shifting their portfolio to bonds, while in 2014 (or more likely 2010) they were shifting their portfolio to equities. But all that illustrates is that rich people aren't stupid and respond to prices like everyone else. Given high real interest rates, they're going to shift their portfolio into bonds, given low (or negative) real interest rates, they're going to shift to equities. In either case, they're going to do well. Had interest rates been low in 1982 or high in 2010 people would have invested money differently and made money either way. They don't benefit from any particular monoetary policy, they benefit from being rich.

[Nick Rowe]

Roger: the "orthodox" view on central banks and interest rates is this:

1. Central banks' choice of monetary policy target affects nominal interest rates. (If the BoC targeted 3% inflation, rather than 2% inflation, nominal interest rates would be approximately 1% higher all the time.)

2. Central banks' choice of monetary policy target, plus mistakes in hitting that target, affect the *variance* of real interest rates, and the covariance of real interest rates with respect to shocks. (We would get a different pattern of real rates under inflation targeting than NGDP targeting.)

3. Central bank's monetary policy target has little effect on average levels of real interest rates.

That's a much more subtle answer than "yes they do" or "no they don't" affect/set interest rates. And, right or wrong, I think it's a much better answer than yes/no.

Bob: I *think* there's an inconsistency there, but I'm not 100% sure. I wasn't being...cute/whatever...when I said my memory is not great. It's not great. And, funnily enough, I only remembered the hippo after posting it. But when I skimmed the bit I've linked to, which was the first decent thing Google found for me on hippos, it did seem to confirm my shaky memory.

But I think we are on the same page.

Part of the problem is that people simply don't get that the inverse relationship between asset prices and interest rates is a mathematical one. The PV formula. They are different ways of talking about the same thing.

[JP Koning]

I was a wee pup in 1982, but here's an example of some of the public's reaction to high rates:

http://www.moaf.org/exhibits/fed/100/volckerwood/:pf_printable/style=print

[Miami vice]

Nick,
Aren't you comparing opposite sides of recessionary events? The fed raised rates because of oil prices in both cases. Didn't they?

I think you're confused and comparing the wrong sequence of events and then poking fun.

[Frank Restly]

"For society to function some kind of reasonable balance has to be stuck between the competing interests of creditors and debtors."

Better words have never been said.

[Kevin Donoghue]

"Central banks are setting high interest rates, which is good for the rich, who have all the money to lend."

I don't think that's what we were saying in 1982. It was more like this: central banks use high interest rates to depress wage inflation, which tilts the balance of power in favour of capital. James Tobin's The Case for Incomes Policies (1983) is worth a look as a reminder of the ideas that were being batted around.

[Nick Rowe]

JP: I vaguely remember demonstrations outside the Bank of Canada.

Miami: "The fed raised rates because of oil prices in both cases. Didn't they?"

Did they? Did the Fed raise interest rates recently?

I thought that in 81/82 central banks raised rates to stop inflation rising, and in 2008 they lowered rates to stop inflation falling.

Frank: compare that sentence to: "For society to function some kind of reasonable balance has to be stuck between the competing interests of sellers of apples and buyers of apples."

Kevin: "I don't think that's what we were saying in 1982. It was more like this: central banks use high interest rates to depress wage inflation, which tilts the balance of power in favour of capital."

What you say some people were saying sounds plausible to me. But why don't we hear the opposite recently? "central banks use low interest rates to increase wage inflation, which tilts the balance of power in favour of labour."

[Miami vice]

Again, you're comparing opposite sides of the recessions. The fed raised then lowered rates in both cases. Not sure what you're on about.

Have a look look at rates and oil prices.

[Phil Koop]

Oh yes, I remember 1982 - there was a lot of competition to find a job!

If "people" is taken to mean ordinary people, my experience is that ordinary people are pretty consistent on this point: with respect to financial investment, high rates are taken to be "good" and low ones "bad", and the effect of rate changes on capital are not taken into account.

The inconsistencies are 1) with house prices, where conversely high prices are taken to be "good" and low ones "bad", and 2) with borrowing, where the same person who was quite pleased to be paid a high rate of interest on side was firmly convinced that "the banks" are ripping him off on his mortgage or his small business loan or whatever.

[Rick T.]

Nick: Sorry for the belated response. "How do you know that 0% isn't the free market interest rate today, and 20% the free market interest rate in 1982? Free market prices fluctuate too."

I absolutely don't know. Nor does Yellen, nor did any previous head of the Fed or any central bank head, present or past. No one knows, because no one person, nor any supercomputer, can read the minds of the hundreds of millions of savers and investors and know how their proclivity to save, consume, or invest might be affected by different rates, and thus affect the free market rate. Only the market knows how to balance those things out, because only the market rate of interest is calculated by what people choose. Any other rate will be the wrong rate, too high or low, and cause economic trouble.

Do you think the government should fix the price of bread or toilet paper? Just look at Venezuela for an example of how that turns out. Then what is it about interest rates that makes them immune to the damage caused by government price fixing of everything else?

That said, I actually do believe that free market rates right now, on their own, if the Fed and other central banks suddenly withdrew from any attempt to control them, would be close to 0%. But that is not because 0% rates, as claimed by the Fed, are a good thing to have because they allegedly will stimulate spending. Rather, I believe that in general interest rates depend very much on what entrepreneurs (broadly defined to include individuals, large corporations, and entities in between) see as returns from potential investments that require more capital than they happen to have. If entrepreneurs see a lot of projects that they can start up or expand that they think, rightly or wrongly, will bring 15% returns on capital, then they will be happy to pay up to perhaps 10%, if need be, to borrow the money to invest. If, as I believe the case to be now, there aren't too many projects that they see that will return much more than 5% on invested capital, then they aren't going to be willing to pay interest rates of more than 1-2% to borrow the needed capital.

So why are entrepreneurs so pessimistic that they don't see high return investment opportunities, and therefore aren't willing to borrow at more than minuscule rates? Obviously, we don't know that they are right - there could be great opportunities all over the place that they are mysteriously ignoring. More likely thought, their viewpoint reflects the damage done to the economy in recent years by the failed attempts to use massive government deficits and artificial 0% interest rates to try to stimulate it. The net effect is we have a populace of a tiny percentage of wealthy people, and a massive number of people living hand to mouth, with little or no savings, large debts of all kind, plus prospect of high taxes to come to pay for their share of debts the government has added on, and slim prospects of ever having a financially comfortable retirement. People in that position are not big buyers of anything, and for that reason any investment in anything, when calculating potential return on investment, must take into account that most potential buyers of the output of that investment are close to broke.

To put it another way, by artificially keeping interest rates at 0% for so long, the central banks have so damaged the underlying balance sheets of the populace that, if there were a not-manipulated free market rate that we could see, it would probably be close to zero now too. But that doesn't make ZIRP, ex post facto, a good idea.

[Kevin Donoghue]

Nick, you ask why don't we hear that central banks use low interest rates to increase wage inflation? Maybe because they are failing dismally? I've no doubt we would hear that sort of thing if inflation picked up, even a little.

Of course, if people were logical they would be saying that central banks are preventing (or at least limiting) deflation. But people aren't logical. Or maybe, like Krugman, they see wages as being sticky-downwards, so they don't give central banks much credit for preventing deflation.

[Bob Smith]

Nick,

I'm too young to remember the 1982 recession, but I certainly recall the reaction (of amongst others, Linda McQuaig) to Bank of Canada policy in the early 1990s, so I think it's fair to say that there is an inconsistency there.

But really, it's just a form of confirmation bias, if you believe that everything is done to benefit the rich, you'll interpret the world in a way that supports your belief. Heads you win, tails I lose.

[Nick Rowe]

Phil and Kevin: sensible points. No real disagreement from me.

Bob: "But really, it's just a form of confirmation bias, if you believe that everything is done to benefit the rich, you'll interpret the world in a way that supports your belief. Heads you win, tails I lose."

That's the view I'm leaning towards. But I hadn't thought of the "confirmation bias" angle.

(I just clicked on your name. I didn't know you were blogging! Good stuff.)

Rick T: your views (even though I disagree with them) are at least symmetric/coherent. We are wandering well off-topic, so I will just leave you with one thought, then we should leave it there.

If the government happens to be the producer of one variety of apples ("government apples"), that are different from other varieties of apples, then it would make sense for the government to set the price (or the quantity, or something) of government apples. It can't *not* set the price (or quantity, or something) of the apples it itself produces.

But that's a discussion for another day.

[Makrointelligenz]

I dont know what they said, but complaining about higher rates to serve the rich back then makes more sense than complaining about the low rates nowadays imo.

[Rick T.]

Nick: Not a bad legalistic argument that, if the government produces all the money ("government apples"), it has the right to set the price for people to borrow or lend that money, i.e., interest rates. But are you sure you want to go that direction? Agreed, this paragraph is far off topic and getting philosophical. Still, the goods and services that people produce to earn those apples are produced by the people, not by the government. Should the government force people to exchange their goods and services not for apples that they choose, but only for government produced apples, and then further force them to do the government's bidding on what one is permitted to do with the apples? Evidently you think so, but why?

Even if government imposed money legally should allow government imposed interest rates, that is not a good argument that there will beneficial results. If the price of loans, i.e., interest rates, like the price of bread or toilet paper, are determined in the market they will accurately reflect true supply and demand, in this case for capital. Central bank determined interest rates have no connection to supply and demand, just to wishful thinking on the part of some academic economists who think they are smarter than the hundreds of millions of savers and investors who make up the market. They central bankers mean well, but they are flying blind and in a losing fight against reality.

[Nick Rowe]

Rick T: In Canada, you and I can use shells as money, if we wish, and borrow and land to each other at any rate of interest we want.

I have already said this is off-topic, and said we should leave it.

There are lots of Austrian blogs where you can explore such topics as you wish.

Stop now.

(I am trying to impose just a little bit of coherence to the comment threads on my blog posts, to stop them degenerating into a place where anyone can go off on any pet hobby horse.)

[Bob Smith]

Macro: "I dont know what they said, but complaining about higher rates to serve the rich back then makes more sense than complaining about the low rates nowadays imo"

Hard to tell, one of the advantages to being rich is that it's a lot easier to borrow a lot of money. I wonder if the Reichman brothers would agree with the proposition that the high interest rates of the last 80's early 90s benefitted them?

[Gzibordi]

I graduated in 1984, in 1982 I was studying Macro in a very left wing department and what my marxist or paleo keynesians were saying was that jacking up interest rates to 13% in the US and even higher in the EU created a terrible recessione and terrible unemployment. Nobody was talking about debt, lending money and the rich lending at higher interest thanks to Volcker. This because at the time private and public debt was 1,5 times GDP and now is between 3 and 4 times GDP. Nobody was buying homes and cars with debt at the time, among the working class, then (at least in Europe), so interest rates did matter for different reasons. Labor shaere of income distribution was the highest at the time and has been going downhill since then so pushing up rates to 13% was bad for labour then and squeezing rates to 0% has been also bad for labour now ? (at least if you look at the numbers). Monetary policy has different effects depending on the ratio of debt to income, but I haven't seen models about that expect for Steve Keen's. Interest rates set by CB matter for international porfolio and fx movements, but not that much for domestic demand and investment.
What happened around 1982 in the whole western world was that "helicopter money" was banned AT THE SAME TIME that interest rates were jacked up to the moon and this was the "policy regime" change that really mattered. After 30 years though, now things are coming around ... see the latest issue of Foreign Affairs: "Print Less but Transfer More -
Why Central Banks Should Give Money Directly to the People" http://www.foreignaffairs.com/articles/141847/mark-blyth-and-eric-lonergan/print-less-but-transfer-more----------
["...Cash transfers stand a better chance of achieving those goals than do interest-rate shifts and quantitative easing, and at a much lower cost. Because they are more efficient, helicopter drops would require the banks to print much less money...] Interest rates matter much less than the quantity of money (credit and CB money) for the majority of the people, they matter mostly for people in financial markets (and macroeconomists)

[Too Much Fed]

Rick T. said: "If, as I believe the case to be now, there aren't too many projects that they see that will return much more than 5% on invested capital, then they aren't going to be willing to pay interest rates of more than 1-2% to borrow the needed capital."

What if these entities do not need to borrow to invest?

[Nick Rowe]

TMF: off-topic. (And not a good question anyway, because it ignores the concept of opportunity cost, and answering it would simply lead to another pointless long and meandering red herring that has nothing to do with my post.)

[Lorenzo from Oz]

Maybe the underlying problem is that many people think about policy actions, when they should be thinking about policy regimes. Thinking about policy regimes imposes a symmetry on our analysis.

Sensible, idea, provided folk have a clue about what a policy regime is, and what the specific policy regime is. A lot of academics don't really have a clue about either, but it doesn't stop them pontificating with great indignity about such.
http://lorenzo-thinkingoutaloud.blogspot.com.au/2014/08/ahistorical-pomposity-and-gnostic.html