How Not to Think about Negative Rates

Last week’s big monetary-policy news was the ECB’s decision to target a negative interest rate, in the form of an 0.25 percent tax on bank reserves. This is the first time a major central bank has announced a negative policy rate, though some smaller ones (like the Bank of Sweden) have done so in the past few years.

Whether a tax on reserves is really equivalent to a negative interest rate, and whether this change should be expected to pass through to interest rates or credit availability for private borrowers, are not easy questions. I’m not going to try to answer them now. I just want to call attention to this rather extraordinary Neil Irwin column, as an example of how unsuited mainstream discussion is to addressing these questions.  
Here’s Irwin’s explanation of what a negative interest rate means:

When a bank pays a 1 percent interest rate, it’s clear what happens: If you deposit your money at the bank, it will pay you a penny each year for every dollar you deposited. When the interest rate is negative, the money goes the other direction. … Put bluntly: Normally the banks pay you to keep your money there. Under negative rates, you pay them for the privilege.

Not mentioned here, or anywhere else in the article, is that people pay interest to banks, as well as receiving interest from them. In Irwin’s world, “you” are always a creditor, never a borrower. 
Irwin continues:

The theory is that when it becomes more costly for European banks to keep money in the E.C.B., they will have incentive to do something else with it: Lend it out to consumers or businesses, for example.

Here’s the loanable funds theory in all its stupid glory. People put their “money” into a bank, which then either holds it or lends it out. Evidently it is not a requirement to be a finance columnist for the New York Times to know anything about how bank loans actually work. 

Banks will most likely pass these negative interest rates on to consumers, or at least try to. They may try to do so not by explicitly charging a negative interest rate, but by paying no interest and charging a fee for account maintenance.

Note that “consumers” here means depositors. The fact that banks also make loans has escaped Irwin’s attention entirely. 
Of course, most of us are already in this situation: We don’t receive any interest rate on our transaction balances, and pay are willing to pay various charges and fees for the liquidity benefits of holding them. 
The danger of negative rates, per Irwin, is that 

It is possible that, assuming banks pass along the negative rates through either fees or explicitly charging negative interest, people will withdraw their money as cash rather than keeping it on deposit at banks. … That is one big reason that the E.C.B. and other central banks are going to be reluctant to make rates highly negative; it could result in people pulling cash out of the banking system.

Again the quantity theory in its most naive and stupid form: there is a fixed quantity of “money” out there, which is either being kept in banks — which function, in Irwin’s world, as glorified safe deposit boxes — or under mattresses. Evidently he’s never thought about why the majority of us who already face negative rates on our checking accounts continue to hold them. More fundamentally, there’s no explanation of what makes negative rates special. Bank deposits don’t, in general, finance holdings of reserves, they finance bank loans. Any kind of expansionary policy must reduce the yield on bank loans and also — if margins are constant — on deposits and other bank liabilities. Making returns to creditors the acid test of policy, as Irwin does, would seem to be an argument against expansionary monetary policy in general — which of course it is.
What’s amazing to me in this piece is that here we have an article about monetary policy that literally makes no mention of loans or borrowers. In Irwin’s world, “you” are, by definition, an owner of financial assets; no other entities exist. It’s the 180-proof distillation of the bondholder’s view of the world.
Heterodox criticism of the loanable-funds theory of interest and insistence that loans create deposits, can sometimes come across as theological, almost ritual.  Articles like this are a reminder of why we can’t let these issues slide, if we want to make any sense of the financial universe in which we live.

Economists: Actively Evil Neoliberal Ideologues or Soulless Technocratic Hacks?

… or in other words, does economics (as it’s currently constituted) inherently promote a vision of markets for everything and no rights but property rights? (A vision that, obviously, conforms nicely to the interests of the owners of capital.) Or is the role of economics in upholding neoliberalism mainly the work of apolitical technicians, administrators and scientists manques, who could just as comfortably supply arguments for more regulation and a larger public sector if that’s what those in power were asking for?

Well, like nature vs. nurture, or whether to get the sweet brunch or the savory, it’s a debate that will never be fully resolved. (Go with savory, unless you’re, like, 12 years old.) But new evidence does sometimes come in.

Like those those polls of economists that the University of Chicago business school does; has everybody seen those? For those of us who’ve been debating this question, these things are a gold mine.

The latest question, on rent control, has Peter Dorman rightly exercised. As he points out, the question — whether rent regulations have had “a positive impact over the past three decades on the amount and quality of broadly affordable rental housing in cities that have used them” — omits the genuine goal of rent regulation, neighborhood stabilization:

The most compelling argument for rent control is neighborhood stabilization, the idea that social capital in an urban environment requires stable residence patterns.  If prices are volatile, and this leads to a lot of residential turnover, the result can be a less desirable neighborhood for everyone.  … not a single textbook treatment of rent control mentions stabilization as an objective, even though this is a standard element in the real-world rhetoric surrounding this issue. 

I would just add that a diversity of income levels in a neighborhood is also a goal of rent regulation, as is recognizing the legitimate interest of long-time tenants in staying in their homes. (Not all rights are property rights!) So by framing the question purely in terms of the housing supply, the Booth people have already disconnected it from actual policy debates in a way favorable to orthodoxy. Anyway, no surprise, orthodoxy wins, with only a single respondent favoring rent regulation. (And I think that one might be a typo.) My favorite answer is the person who said, ” Rent control will have similar effects to any price control.” That’s the beauty of economics, isn’t it? — all markets are exactly the same.

Some of the other ones are even better. Check out the one on education, which asks if all money currently being spent on K-12 education should be given out as vouchers instead. (Why not cash?) By a margin of 36 to 19 (or 41 to 23 when the answers are weighted by confidence) the economists vote, Hells yeah, let’s abolish the public school system. Presumably they’re mostly reasoning along the same lines as Michael Greenstone of MIT: ” Competition is likely beneficial on average. Less clear that all students would benefit leading to tough questions about social welfare functions” — which doesn’t stop him from signing up in favor of vouchers. The presumed benefits of competition are dispositive, while distributional questions, while “tough” in principle, can evidently be ignored in practice. On the other hand, props to Nancy Stokely of the U of C (strongly agree, confidence 9 out of 10) for spelling it right out: “It’s the only way to break the unions.” (Yes, that’s what she wrote.) So, hardly definitive, but definitely some ammo for Team Ideologue.

People sometimes say that academic economists just reflect the views of the country at large, or even the more-liberal-than-median views of other academics or educated professionals. And on some issues, that’s certainly true. (Booth also gets a solid majority in favor of drug law reform.) But come on. Replacing the public school system with vouchers is a far-right, fringe position in almost any significant demographic — except, it would seem, professional economists.

Back to rent control. Jodi Beggs enthusiastically endorses the consensus, but her conscience then compels her to add:

Techhhhhnically speaking [1], if none of the housing in an area was deemed “affordable” before the price ceiling, then the price ceiling could, I suppose, increase the quantity of affordable housing. (In fact, Pinelopi Goldberg specifically points this out.) [True. Goldberg’s answers in general are a beacon of sanity.] In most realistic cases, however, the rent control laws are going to make builders think twice about putting up residential properties and make potential landlords think twice about getting into the rental business. 

It’s awfully hard not to read the drawn out adverb as a parapraxis, indicating resistance to the heretical thought that, in fact, economic theory gives no answer to the question of whether rent control laws increase or decrease the supply of affordable housing. More concretely, Begg’s “realistic cases” are a figment of her imagination, or rather her ideology; in all actual cases rent control laws, at least in major American cities (there are only a couple) only apply to units built before a certain date. In New York City, for instance, rent regulations DO NOT APPLY to anything built since 1974. Hard to believe that builders are thinking twice about putting up new buildings because of rent stabilization, when it hasn’t applied to new buildings in nearly 40 years. But hey, why should you have to actually know something about the policy you’re discussing, to walk through the old familiar supply and demand graphs showing why Price Controls Are Bad?

“Nothing dulls the mind,” says Feyerabend, “as thoroughly as a sequence of familiar notions.”

(I can’t resist putting down the quote in full:

Writing… [is] almost like composing a work of art. There is some overall pattern, very vague at first, but sufficiently well defined to provide … a starting point. Then come the details — arranging the words in sentences and paragraphs. I choose my words very carefully — they must sound right, must have the right rhythm, and their meaning must be slightly off-center; nothing dulls the mind as thoroughly as a sequence of familiar notions. Then comes the story. It should be interesting and comprehensible, and it should have some unusual twists. I avoid “systematic” analyses. The elements hang together beautifully, but the argument itself is from outer space, as it were, unless it is connected with the lives and interests of individuals or special groups. Of course, it is already so connected, otherwise it would not be understood, but the connection is concealed, which means that, strictly speaking, a “systematic” analysis is a fraud. So why not avoid the fraud by using stories right away?)

Noah Clue

Hey you guys! You know how unemployment has been, like, real high for years now, and nobody knows why? Noah Smith has figured it out:

an economic principle often overlooked by progressives: There is sometimes a tradeoff between wages and employment levels (which is another way of saying that labor supply curves slope up and labor demand curves slope down). If economic “frictions” or the actions of policymakers hold wages up when economic forces are trying to push wages down, unemployment will often result. 

I think he learned it in an economics class!

You remember how there were these economic forces in 2007 that decided wages had to go down, but we got all these new policies to raise wages like, you know, all those wage-raising things that Bush did? Well, that’s why unemployment went up by 5 points in less than two years. 

I mean, it’s so simple when you think about it. “Labor demand curves slope down,” that’s all you need to know. We learn that the first year of micro, supply curves slope up, demand curves slope down. Demand for labor, demand for cottage cheese, doesn’t matter, they’re just the same. Why do they even bother offering courses in macro?
It’s funny, though: Wasn’t there some guy who wrote a whole book about why lower wages don’t raise employment? Maynard, or some weird name like that? Well, Noah’s never heard of him, or of his book (the General Theory of something?) but he can’t be worth bothering with, can he? after all, he didn’t even realize that demand curves slope down! Which is all you need to know.
Of course, lower wages won’t help employment if there is already an excess supply of labor. If people are already willing to work for less than the going wage, telling them they should accept less than the going wage can’t be the solution. What would we call a situation like that? How about … “involuntary unemployment”? But Noah Smith is too smart for that, he knows that could never happen. He knows that markets always clear, employment is always at the intersection of the labor supply curve and the labor demand curve, so the only way to raise employment must be to move the labor supply curve downward. It’s just Econ 101, and Econ 101 is never wrong.
Of course, if you think that wages are equal to the marginal product of labor, the demand curve for labor will only slope downward when the marginal product of labor is falling — which might not be the case when output is far from potential. But Noah Smith knows that demand curves always slope downward, so there can’t be any range of output over which the mpl is more or less constant.
But wait, what if labor markets are monopsonistic? Then the observed labor demand curve can slope upward. And monopsony in labor markets doesn’t require a company town, all it requires is that a firm’s labor costs are rising in employment. Or in other words that if a firm cuts wages moderately, it will lose some but not all of its workers. (Crazy talk, I know.) Which is the natural result of labor market models with search frictions. This is one reason why the most rigorous empirical studies of legislated wage changes show no sign of a downward sloping labor demand curve. But Noah Smith doesn’t need to trouble his beautiful mind with empirical evidence, or learn any of that silly labor economics stuff, because he knows that labor demand curves slope downward. He learned it in introductory micro!
And then there’s that little difference between labor and cottage cheese, that wages make up the large majority of producers’ variable costs. So we have to think general equilibrium here, not just partial. Prices, in the first instance, are set as a markup over marginal costs. [1] So if you reduce money wages, you don’t reduce real wages by as much, because you reduce the price level as well. That means deflation, which is … let’s see, not always super great for employment. That Maynard dude wrote something about that too, I think, and so did some other old guy, Hunter or Trapper or something. Apparently there was this crazy idea that falling wages and prices were a problem back in Ancient Rome, or maybe the 1930s (same thing). But Noah goes to a good graduate school, so he knows that no real economist bothers with dusty old stuff like that. After all it’s not like there are any lessons we could learn from the Great Depression, or the Punic Wars or whatever it was. Not when we know that labor demand curves slope down!
Oh and hey, there’s another difference between labor and cottage cheese! (Who’d have thought?) Wages are also a source of demand. Pop quiz for Noah Smith: Which is a more important component of final demand, consumption out of wages, or net exports? Yeah, that would be door number one. So maybe, just maybe, whatever competitive advantage lower wages yield in lower unit labor costs might be offset by lower consumption demand by wage-earners? And that’s assuming that changes in wages are fully passed through into the relative price of tradables, and that trade flows are price-elastic. [2] But hey, you know what happens when you assume: it makes you an … economist. Now, if it were the case that wages were an important source of final demand, and if output is demand-constrained, then lowering wages might not raise demand for labor, even if labor markets were fully competitive and if changes in nominal wages translated one for one into changes in real wages. But that’s unpossible! because, as we all know, the demand curve for labor slopes down.
Well, but demand doesn’t matter, since Noah knows — he learned it in school — the economy is always at full employment. If we observe fewer people working, it can’t be because aggregate demand has fallen, it can only be because an artificially high price of labor has led to substitution away from labor to other factors of production. It couldn’t possibly be the case that when unemployment is high, capital is underutilized as well too, could it? Because that would mean that the wage share and the profit share were both too high, which is like saying that x>y and y>x. So no, we couldn’t possibly observe anything like this:
Because we know — it’s economics 101 — that high unemployment can only ever be the result of substitution away from labor because of changes in relative prices, not a lower level of output for the economy as a whole. Altho, gosh, it sure looks like capacity utilization falls in recessions just like employment does, which would suggest that cyclical unemployment has nothing to do with the relative price of labor.
So, ok, we can forget Keynes and all that old nonsense. And let’s ignore the effect of nominal wage changes on prices. And put out of our mind any question about whether the marginal product of labor is really declining over current levels of output, or about imperfect competition in labor markets. And we’ll ignore the role of wages as a source of demand. And we’ll unlearn any information we might have accidentally picked up about the empirical relationship between wages and employment, or about the Great Depression. And we’ll stick our fingers in our ears if anyone suggests that unemployment today is associated with demand constraints on output rather than substitution away from labor. And then we can be as smart as Noah Smith! And we’ll know how to fix unemployment:
In Germany, labor unions often negotiate wage cuts in order to preserve long-term employment levels. I think we should look at doing something similar.
You guys, wage concessions! Has anybody in the US labor movement ever thought of that? I bet it will work great! It’s pretty ballsy of Noah Smith to stand up against Big Labor, but someone’s got to, right? I mean, unions represent almost 7 percent of the private workforce. If someone is holding wages above the level that Economic Forces want them to be at, who else could it be?
Hey, I wonder if any other countries are getting advice from smart economists like Noah Smith, and are fixing all their problems by cutting wages? You know, I think there are some. How about Latvia? The authorities there were all, like, wages are going down. And guess what? While in the US unemployment has gone from 5% in 2007 to over 8% today, in Latvia it went from 5% to … 14%? Well, who cares about some little Baltic country, let’s talk about the UK. They got real wages down by 2.7 percent last years (2.1 percent nominal growth less 4.8 percent inflation.) And hey, look at employment — it’s skyrocketing continuing to fall, and now the lowest it’s been since 2003.
You know what? I’m beginning to think that “labor demand curves slope down” might not be the best way to think about unemployment. Maybe it is helpful to know something about macroeconomics, after all.

[1] Or equal to marginal costs if you like; the point is the same.

[2] I’ve presented some evidence on whether trade flows are responsive to relative costs in practice in these posts.