October 2020 – J. W. Mason

On Negative Rates

Negative interest rates – weird, right?

In the five thousand years that interest rates have been recorded, they’ve never hit zero before. Today, there’s some $15 trillion in negative-yielding bonds — admittedly down from $17 trillion last year, but still a very substantial fraction of the global bond market outside the US. At first it was only shorter bonds that were negative, but today German bunds are negative all the way out to 30 years. What’s going on? Does this mean it would be profitable to bulldoze the Rockies for farmland? Will it cause the extinction of the banking system? And more fundamentally, if the interest rate reflects the cost of a good today in terms of the same good next year, why would it ever be negative? Why would people place a higher value on stuff in the future than on stuff today?

Personally, I don’t think they’re so weird. And the reason I think that is that interest rates are not, in fact, the price of goods today in terms of goods tomorrow. It is, rather, the price of a financial asset that promises a certain schedule of money payments. Negative rates are only a puzzle in the real-exchange perspective that dominates economics, where we can safely abstract from money when discussing interest rates. In the money view, where interest transactions are swap of assets, or of a stream of money payments, nothing particularly strange about them.

(I should say up front that this post is an attempt to clarify my own thinking. I think what I’m writing here is right, but I’m open to hearing why it’s wrong, or incomplete. It’s not a finished or settled position, and it’s not backed up by any larger body of work. At best, like most of what I wrote, it is informed by reading a lot of Keynes.)

The starting point for thinking about negative rates is to remember that these are market prices. Government is not setting a negative yield by decree, someone is voluntarily holding all those negative-yielding bonds. Or more precisely, someone is buying a bond at a price high enough, relative to the payments it promises, to imply a negative yield.

Take the simplest example — a government bond that promises a payment of $100 at some date in the future, with no other payments in between. (A zero-coupon bond, in other words.) If the bond sells today for less than $100, the interest rate on it is positive. If the bond sells today for more than $100, the interest rate is negative. Negative yields exist insofar market participants value such a bond at greater than $100.

So now we have to ask, what are the sources of demand for government bonds?

A lot of confusion is created, I think, by asking this question the wrong way. People think about saving, and about trading off spending today against spending tomorrow. This after all is the way an economics training encourages you to think about interest rates — as a shorthand for any exchange between present and future. Any transaction that involves getting less today in return for more tomorrow incorporates the interest rate as part of the price — at a high enough level of abstraction, they’re all the same thing. The college wage premium, say, is just as much an interest rate from this perspective as the yield on the bond.

If we insist on thinking of interest rates this way, we would have to explain negative yields in terms of a society-wide desire to defer spending, and/or the absence of any store of wealth that even maintains its value, let alone increases it. Either of those would indeed be pretty weird!

(Or, it would be the equivalent of people paying more for a college education than the total additional wages they could expect to earn from it, or people paying more for a house than the total cost of renting an identical one for the rest of their lives. Which are both things that might happen! But also, that would be generally seen as something going wrong in the economic system.)

Since economists (and economics-influenced people) are so used to thinking of interest as reflecting a tradeoff between present and future, a kind of inter-temporal exchange rate, it’s worth an example to clarify why it isn’t. Imagine a typical household credit transaction, a car loan. The household acquires means to pay for the acquisition of a car, and commits to a schedule of payments to the bank; the bank gets the opposite positions. Is the household giving up future consumption in order to consume now? No. At every period, the value the household gets from the use of the car will exceed the payments the household is making for it — otherwise, they wouldn’t be doing it. If anything, since the typical term of a car loan is six or seven years while a new car should remain in service for a decade or more, the increased consumption comes in the future, when the car is paid off and still delivering transport services. Credit, in general, finances assets, not consumption. The reason car loans are needed is not to shift consumption from the future to the present, but because use of the transportation services provided by the car are tightly bound up with ownership of the car itself.

Nor, of course, is the lender shifting present consumption to the future. The lender itself, being a bank, does not consume. And no one else needs to forego or defer consumption for the banks to make the auto loan either. No one needs to deposit savings in a bank before it makes a loan; the lent money is endogenous, created by banks in the course of lending it. Whatever factors limit the willingness of the bank to extend additional auto loans — risk; liquidity; capital; regulation; transaction costs — a preference for current consumption is not among them.

The intertemporal-exchange way of looking at government bonds would make sense if the only way to acquire one was to forego an equal amount of consumption, so that bond purchases were equivalent to saving in an economic sense. Then understanding the demand for government bonds, would be the same as understanding the desire to save, or defer consumption. But of course government bonds are not part of some kind of economy-wide savings equilibrium like that. First of all, the purchasers of bonds are not households, but banks and other financial actors. Second, the purchase of the bond does not entail a reduction in current spending, but a swap of assets. And third, the owners of bonds do not hold them in order to finance some intended real expenditure in the future, but rather for some combination of benefits from owning them (liquidity, safety, regulation) and an expectation of monetary profit.

From the real-exchange perspective, there is one intertemporal price — the interest rate — just as there is one exchange rate between any given pair of countries. From the money view perspective, there are many different interest rates, corresponding to the different prices of different assets promising future payments. Many of the strong paradoxes people describe from negative rates only exist if rates are negative across the board. But in reality, rates do not move in lockstep. We will set aside for now the question of how strong the arbitrage link between different assets actually is.

We can pass over these questions because, again, government bonds are not held for income. They are not held by households or the generic private sector. They are overwhelmingly held by banks and bank-like entities for some combination of risk, liquidity and regulatory motives, or by a broader set of financial institutions for return. Note for later: Return is not the same as income!

Let’s take the first set of motivations first.

If you are a bank, you may want to hold some fraction of your assets as government bonds in order to reduce the chance your income will be very different from what you expected; reduce the chance that you will find yourself unable to make payments that you need or want to make (since it’s easy to sell the bonds as needed); and/or to reduce the chance that you’ll fall afoul of regulation (which presumably is there because you otherwise might neglect the previous two goals).

The key point here is that these are benefits of holding bonds that are in addition to whatever return those bonds may offer. And if the ownership of government bonds provides substantial benefits for financial institutions, it’s not surprising they would be willing to pay for those services.

This may be clearer if we think about checking accounts. Scare stories about negative rates often ask what happens when households have to pay for the privilege of lending money to the bank. Will they withdraw it all as cash and keep it under the mattress? But of course, paying the bank to lend it money is the situation most people have always been in. Even before the era of negative rates, lots of people held money in checking accounts that carried substantial fees (explicit and otherwise) and paid no interest, or less than the cost of the fees. And of course unbanked people have long paid exorbitant amounts to be able to make electronic payments. In general, banks have no problem getting people to hold negative-yield assets. And why would they? The payments services offered by banks are valuable. The negative yield just reflects people’s willingness to pay for them.

In the national accounts, the difference between the interest that bank depositors actually receive and a benchmark rate that they in some sense should receive is added to their income as “imputed interest”, which reflects the value of the services they are getting from their low- or no- or negative-interest bank accounts. In 2019, this imputed interest came to about $250 billion for households and another $300 billion for non financial corporations. These nonexistent interest payments are, to be honest, an odd and somewhat misleading thing to include in the national accounts. But their presence reflects the genuine fact that people hold negative and more broadly below-market yield assets in large quantities because of other benefits they provide.

Turned around this way, the puzzle is why government debt ever has a positive yield. The fundamental form of a bond sale is the creating of pair of offsetting assets and liabilities. The government acquires an asset in the form of a deposit, which is the liability of the bank; and the bank acquires an asset in the form of a bond, which is the liability of the government. Holding the bond has substantial benefits for the bank, while holding the deposit has negligible benefits for the government. So why shouldn’t the bank be the one that pays to make the transaction happen?

One possible answer is the cost of financing the holding. But, it is normally assumed that the interest rate paid by banks follows the policy rate. There’s no obvious reason for the downward shift in rates to affect spread between bank deposits and government bonds. Of course some bank liabilities will carry higher rates, but again, that was true In the past too.

Another possible answer is the opportunity cost of not holding positive-yield asset. Again, this assumes that other yields don’t move down too. More fundamentally, it assumes a fixed size of bank balance sheets, so that holding more of one asset means less of another. In a world with with a fixed or exogenous money stock, or where regulations and monetary policy create the simulacrum of one, there is a cost to the bank of holding government debt, namely the income from whatever other asset it might have held instead. Many people still have this kind of mental model in thinking about government debt. (It’s implicit in any analysis of interest rates in terms of saving.) But in a world of endogenous credit money, holding more government debt doesn’t reduce a bank’s ability to acquire other assets. Banks’ ability to expand their balance sheets isn’t unlimited, but what limits it is concerns about risk or liquidity, or regulatory constraints. All of these may be relaxed by government debt holdings, so holding more government bonds may increase the amount of other assets banks can hold, not reduce it. In this case the opportunity cost would be negative.

So why aren’t interest rates on government debt usually negative? As a historical matter, I suppose the reasons we haven’t seen negative yields in the past are, first, that under the gold standard, government bonds were not at the top of the hierarchy of money and credit, and governments had to pay to access higher-level money; in some contexts government debt may have been lower in the hierarchy than bank money as well. Second, in the postwar era the use of the interest rate for demand control has required central banks to ensure positive rates on public as well as private debt. And third, the safety, liquidity and regulatory benefits of government debt holdings for the financial system weren’t as large or as salient before the great financial crisis of 2007-2009.

Even if negative yields aren’t such a puzzle when we think about the sources of bank demand for government debt, we still have the question of how low they can go. Analytically, we would have to ask, how much demand is there for the liquidity, safety and regulatory-compliance services provided by sovereign debt holdings, and to what extent are there substitute sources for them?

But wait, you may be saying, this isn’t the whole story. Bonds are held as assets, not just as reserves for banks and bank-like entities. Are there no bond funds, are there no bond traders?

These investors are the second source of demand for government bonds. For them, return does matter. The goal of making a profit from holding the bond is the second motivation mentioned earlier.

The key point to recognize here is that return and yield are two different things. Yield is one component of return. The other is capital gains. The market price of a bond changes if interest rates change during the life of the bond, which means that the overall return on a negative-yielding bond can be positive. This would be irrelevant if bonds were held to maturity for income, but of course that is not bond investment works.

For foreign holders, return also includes gains or losses from exchange rate changes, but we can ignore that here. Most foreign holders presumably hold government bonds as foreign exchange reserves, which is a subset of the safety/liquidity/regularity benefits discussed above.

To understand how negative yielding bonds could offer positive returns, we have to keep in mind what is actually going on with bond prices, including negative rates. The borrower promises one or more payments of specified amounts at specified dates in the future. The purchaser then offers a payment today in exchange for that stream of future payments. What we call an interest rate is a description of the relationship between the promised payments and the immediate payment. We normally think of interest as something paid over a period of time, but strictly speaking the interest rate is a price today for a contract today. So unlike in the checking account case, the normal negative-rates situation is not the lender paying the borrower.

Here’s an example. Suppose I offer to pay you $100 30 years from now. This is, formally, a zero-coupon 30-year bond. How much will you pay for this promse today?

If you will pay me $41 for the promise, that is the same as saying the interest rate on the loan is 3 percent. (41 * 1.03 ^ 30 = 100). So an interest rate of 3 percent is just another way of saying that the current market price of a promise of $100 30 years from now is $41.

If you will pay me $55 for the promise, that’s the same as an interest rate of 2 percent. If you’ll pay me $74, that’s the same as an interest rate of 1 percent.

If you’ll pay me $100 for the promise, that is of course equivalent to an interest rate of 0. And if you’ll pay me $135 for the promise of $100 30 years from now, that’s the equivalent of an interest of -1 percent.

When we look at things this way, there is nothing special about negative rates. There is just continuous range of prices for an asset. Negative rates refer to the upper part of the range but nothing in particular changes at the boundary between them. Nothing magical or even noticeable happens when the price of an asset (in this case that promise of $100) goes from $99 to $101, any different from when it went from $97 to $99. The creditor is still paying the borrower today, the borrower is still paying the creditor in the future.

Now the next step: Think about what happens when interest rates change.

Suppose I paid $135 for a promise of $100 thirty years from now, as in the example above. Again, this equivalent to an interest rate of -1 percent. Now it’s a year later, so I have a promise of $100 29 years from now. At an interest rate of -1 percent, that is worth $133.50. (The fact that the value of the bond declines over time is another way of seeing that it’s a negative interest rate.) But now suppose that, in the meantime, market interest rates have fallen to -2 percent. That means a promise of $100 29 years from now is now worth $178. (178 * 0.98 ^ 29 = 100.) So my bond has increased in value from $135 to $178, a capital gain of one-third! So if I think it is even modestly more likely that interest rates will fall than that they’ll rise over the next year, the expected return on that negative-yield bond is actually positive.

Suppose that it comes to be accepted that the normal, usual yield on say, German 10-year bunds is -1 percent. (Maybe people come to agree that the liquidity, risk and regulatory benefits of holding them are worth the payment of 1 percent of their value a year. That seems reasonable!) Now, suppose that the yield starts to move toward positive territory – for concreteness, say the current yield reaches 0, while people still expect the normal yield to be -1 percent. This implies that the rise to 0 is probably transitory. And if the ten-year bund returns to a yield of -1 percent, that implies a capital gain on the order of 10 percent for anyone who bought them at zero. This means that as soon as the price begins to rise toward zero, demand will rise rapidly. And the bidding-up of the price of the bund that happens in response to the expected capital gains, will ensure that the yield never in fact reaches zero, but stops rising before gets much above -1 percent.

Bond pricing is a technical field, which I have absolutely no expertise in. But this fundamental logic has to be an important factor in decisions by investors (as opposed to financial institutions) who hold negative-yielding bonds in their portfolios. The lower you expect bond yields to be in the future, the higher the expected return on a bond with a given yield today. If a given yield gets accepted as usual or normal, then expected capital gains will rise rapidly when the yield rises above that — a dynamic that will ensure that the actual yield does not in fact depart far from the normal one. Capital gains are a bigger part of the return the lower the current yield is. So while high-yielding bonds can see price moves in response to fundamentals (or at least beliefs about them), these self-confirming expectations (or conventions) are likely to dominate once yields fall to near zero.

These dynamics disappear when you think in terms of an intertemporal equilibrium where future yields are known and assets are held to maturity. When we think of trading off consumption today for consumption tomorrow, we are implicitly imagining something equivalent to holding bond to maturity. And of course if you have a model with interest rates determined by some kind of fundamentals by a process known to the agents in the model — what is called model-consistent or rational expectations — than it makes to sense to say that people could believe the normal or “correct” level of interest rates is anything other than what it is. So speculation is excluded by assumption.

Keynes understand all this clearly, and the fact that the long-term interest rate is conventionally determined in this way is quite important to his theory. But he seems never to have considered the possibility of negative yields. As a result he saw the possibility of capital gains as disappearing as interest rates got close to zero. This meant that for him, the conventional valuation was not symmetrical, but operated mainly as a floor. But once we allow the possibility of negative rates, conventional expectations can prevent a rise in interest rates just as easily as a fall.

In short, negative yields are a puzzle and a problem in the real exchange paradigm that dominates economic conversation, in which the “interest rate” is the terms on which goods today exchange for goods in the future. But from the money view, where the interest rate is the (inverse of) the price of an asset yielding a flow of money payments, there is nothing especially puzzling about negative rates. It just implies greater demand for the relevant assets. A corollary is that while there should be a single exchange rate between now and later, the prices of different assets may behave quite differently. So while many of the paradoxes people pose around negative rates assume that all rates go negative together, in the real world the average rate on US credit cards, for example, is still about 15 percent — the same as it was 20 years ago.

In the future, the question people may ask is not how interest rates could be negative, but why was it that the government for so long paid the banks for the valuable services its bonds offered them?

Money and Cryptocurrencies

(This is an edited and expanded version of a talk I gave in Trento, Italy in June 2018, on a panel with Sheila Dow.)

The topic today is “Digital currencies: threat or opportunity?”

I’d like to offer a third alternative: New digital currencies like bitcoin are neither a threat or an opportunity. They do not raise any interesting economic questions and do not pose any significant policy problems. They do not represent any kind of technological advance on existing payment systems, which are of course already digital. They are just another asset bubble, based on the usual mix of fraud and fantasy. By historical standards, they are not a very large or threatening bubble. There is nothing important about them at all.

Why might you conclude that the new digital currencies don’t matter?

– Aggregate size – the total value of all bitcoin is on the order of $200 billion, other digital currencies are much smaller. On the scale of modern financial markets that’s not much more than a rounding error.

– No articulation with the rest of the financial system. No banks or other important institutions rely on cryptocurrencies to settle transactions, or have substantial holdings on their balance sheets. They’re not used as collateral for loans.

– Not used to structure real activity. No significant part of collective productive or reproductive activity is organized by making payments or taking positions in cryptocurrencies.

Besides that, these currencies don’t even do what they claim to do. In practice, digital currencies do depend on intermediaries. Payment is inconvenient and expensive — as much as $14 per transaction, and accepted by only 3 of top 500 online retailers. And markets in these currencies are not decentralized, but dominated by a few big players. All this is documented in Mike Beggs’ wonderful Jacobin article on cryptocurrencies, which I highly recommend.

Compare this to the mortgage market. Total residential mortgages in the US are over $13 trillion, not far short of GDP. The scale is similar in many other countries. Mortgages are a key asset for the financial system, even when not securitized. And of course they play a central role in organizing the provision of housing (and commercial space), an absolutely essential function to social reproduction.

And yet here we are talking about cryptocurrencies. Why?

Partly it’s just hard money crankery and libertarianism, which have a outsized voice in economics discussions. And partly it’s testimony to the success of their marketing machine. One might say that the only thing that stands behind that $200 billion value, is the existence of conversations like this one.

But it’s not just cranks and libertarians who care about cryptocurrencies. Central bank research departments are earnestly exploring the development of digital currencies. This disproportionate attention reflects, I think, some deeper problems with how we think of money and central banking. The divide over whether crypto-currencies represent anything new or important reflects a larger divide over how we conceive of the monetary system.

In the language of Schumpeter — whose discussion in his History of Economic Thought remains perhaps the best starting point for thinking about these things — it comes down to whether we “start from the coin.” If we start from the coin, if we think of money as a distinct tangible thing, a special kind of asset, then bitcoin may look important. We could call this the quantity view of money. But if we follow Schumpeter — and in different ways Hyman Minsky, Perry Mehrling and David Graeber — and start from balance sheets, then it won’t. Call this the ledger view of money.

In the quantity view, “money” is something special. The legal monopoly of governments on printing currency is very important, because that is money in a way that other assets aren’t. Credit created by banks is something different. Digital currencies are a threat or opportunity, as the case may be, because they seem to also go in this exclusive “outside money” box.

But from the Minsky-Mehrling-Graeber point of view, there’s nothing special about outside money. It’s just another set of tokens for recording changes in the social ledger. What matters isn’t the way that changes are recorded, but the accounts themselves. From this perspective, “money” isn’t an asset, a thing, it is simply the arbitrary units in which ledgers are kept and contracts denominated.

The starting point, from this point of view, is a network of money payments and commitments. Some of these commitments structure real activity (I show up for work because I expect to receive a wage). Others are free-standing. (I pay you interest because I owe you a debt.) In either case money is simply a unit of account. I have made a promise to you, you have a made a promise to someone else; these promises are in some cases commitments to specific concrete activities (to show up for work and do what you’re told), but in other cases they are quantitative, measured as a certain quantity of “money.”

What does money mean here? Simply whatever will be accepted as fulfilment of the promise, as specified in whatever legal or quasi-legal provisions govern it. It is entirely possible for the unit of account to have no concrete existence at all. And in any case the concrete assets that will be accepted are never identical; their equivalence is to some extent a fiction enshrined in the terms of the contract, and to some extent the result of active interventions by whatever authorities are responsible for the payments system.

In short, the fact that some particular asset that serves as money in this or that case is not very interesting. What matters is the balance sheets. Money is just a means of recording changes on balance sheets, of making transfers between ledgers. If we take the ledger view, then there’s no difference between physical currency and an instrument like a check. In either case the social ledger maintained by the banking system has a certain credit to you. You want to transfer a part of that to someone else, for whatever reason. So you give that person a piece of paper with the amount written on it, and they take it to their bank, which adjusts the social ledger accordingly. It makes no difference whether the piece of paper is a dollar or euro bill or a check or a money order, any more than it matters what its physical dimensions are or whether it is one sheet of paper or two.

And of course the majority of transactions are made, the majority of obligations, are settled without using pieces of paper at all. In fact the range of transactions you can carry out using the pieces of paper we call “money” is rather limited.

To put it another way: At the train station there are various machines, which will give you a piece of paper while debiting your bank account. Some of those pieces of paper can be used in exchange for a train ride, others for various other purposes. We call one a ticket machine and one an ATM. But conceptually we should think of them as the same kind of machine. Both debit your social ledger and then give you a claim on something concrete — a paper from the newsstand, say, or a train ride, as the case may be.

In the quantity view of money, there is some special asset called money which the rest of the payments system builds off. So the fact that something else could “be” money seems important. It matters that the government has a legal monopoly on printing currency, so it also matters that something like cryptocurrency seems to evade that monopoly. In the ledger view, on the other hand, that legal monopoly doesn’t matter at all. There are lots of systems for making transfers between bank accounts, including many purely electronic ones. And there are social ledgers maintained by institutions that we don’t officially recognize as banks. New digital currencies introduce a few more of each. So what?

In the quantity view, money and credit are two distinct things. We start with money, which might then be lent. This is how we learn it as children. In the ledger view, money is just anything that settles an obligation. And that is constantly done by promises or IOUs. The fact that “banks create money” in our modern economy isn’t some kind of innovation out of an original situation of cash-on-the-barrelhead exchange. Rather, it is a restriction of money-creation from the historical situation where third-party IOUs of all kinds circulated as payment.

Related to this are two different views of central banks. In the quantity view, the fundamental role of the central bank is in some sense setting or managing the money supply. In the ledger view, where money is just an arbitrary subset of payments media, which is constantly being created and destroyed in the course of making payments, “the money supply” is a nonsense term. What central banks are doing in this view is controlling the elasticity of the credit system. In other words, they are managing the willingness and ability of economic units to make promises to each other.

There are a variety of objectives in this; two important ones today are to control the pace of real activity via the elasticity of money commitments (e.g. to keep the wage share within certain bounds by controlling the level of aggregate employment) and to maintain the integrity of the payments system in a crisis where a wave of self-perpetuating defaults is possible.

In either case the thing which the central bank seeks to make more scarce or abundant is not the quantity of some asset labeled as “money”, but the capacity to make promises. To reduce the level of real activity, for example, the central bank needs to make it more difficult for economic units to make claims on real resources on the basis of promises of future payments. To avoid or resolve a crisis the central bank needs to increase the trustworthiness of units so they can settle outstanding obligations by making new promises; alternatively it can substitute its own commitments for those of units unable to fulfill their own.

Now obviously I think the ledger view is the correct one. But many intelligent people continue to work with a quantity view, some explicitly and some implicitly. Why? I think one reason is the historical fact that during the 20th century, the regulatory system was set up to create a superficial resemblance to the quantity theory. The basic tool of monetary policy was restrictions on the volume of credit creation by banks, plus limits on ability of other institutions to perform bank function. But for various reasons these restrictions were formalized as reserve requirements , and policy was described as changing quantity of reserves. This created the illusion we were living in world of outside money where things like seignorage are important.

Axel Leijonhufvud has given a brilliant description of how regulation created this pseudo quantity of money world in several essays, such as “So Far from Ricardo, So Close to Wicksell.”

Now this structure has been obsolete for several decades but our textbooks and our thinking have not caught up. We still have an idea of the money multiplier in our head, where bank deposits are somehow claims on money or backed by money. Whereas in reality they simply are money.

The fact that money as an analytic category is obsolete and irrelevant, doesn’t mean that central banks don’t face challenges in achieving their goals. They certainly do. But they have nothing to do with any particular settlement asset.

I would frame them the problems like this:

First, the central bank’s established instruments don’t reliably affect even the financial markets most directly linked to them. This weak articulation between the policy rates and other rates has existed for a while. If you look back to 2000-2001, in those two years the Federal Reserve reduced the overnight rate by 5 points. But corporate bond rates fell only one point, and not until two years later. Then in 2003-2006, when the Fed raised its rate by 4 points, the bond rates did not rise at all.

Second, neither real economic behavior nor financial markets respond reliably to interest rate changes. It’s a fiction of the last 25 years — though no longer than that — that this one instrument is sufficient. The smugness about the sufficiency of this tool is really amazing in retrospect. But it’s obvious today — or it should be — that even large changes in interest rates don’t reliably affect either the sclae of concrete activity or the prices of other assets.

Third, there is no single right amount of elasticity. A credit system elastic enough to allow the real economy to grow may be too elastic for stable asset prices. Enough elasticity to ensure that contracts are fulfilled, may be too much to avoid bidding up price of real goods/factors.

People who acknowledge these tensions tend to assume that one goal has to be prioritized over the others. People at the Bank for International Settlements are constantly telling us that financial stability may require accepting persistent semi-depression in real activity. Larry Summers made a splash a few years ago by claiming that an acceptable level of real activity might require accepting asset bubbles. From where I am sitting, there are just competing goals, which means this is a political question.

Fourth, the direction as well as volume of credit matters. In discussion like this, we often hear invocations of “stability” as if that were only goal of policy. But it’s not, or even the most important. The importance of crises, in my opinion, is greatly overrated. A few assets lose their values, a few financial institutions go bust, a few bankers may go to jail or leap out of windows — and this time we didn’t even get that. The real problems of inequality, alienation, ecology exist whether there is a financial crisis or not. The real problem with the financial system is not that it sometimes blows up but that, in good times and bad, it fails to direct our collective capabilities in the direction that would meet human needs. Which today is an urgent problem of survival, if we can’t finance transition away from carbon fast enough.

For none of these problems does some new digital currency offer any kind solution. The existing system of bank deposits is already fully digital. If you want set up a postal banking system — and there’s a lot to recommend it — or to recreate the old system of narrow commercial banking, great. But blockchain technology is entirely irrelevant.

The real solution, as I have argued elsewhere (and as many people have argued, back to Keynes at least) is for central banks to intervene at many more points in financial system. They have to set prices of many assets, not just one overnight interest rate, and they have to direct credit to specific classes of borrowers. They have to accept their role as central planner. It is the need for much more conscious planning of finance, and not crypto currencies, that, I think, is the great challenge and opportunity for central banks today.

The Coronavirus Recession Is Just Beginning

(A couple days ago I gave a talk — virtually, of course — to a group of activists about the state of the economy. This is an edied and somewha expanded version of what I said.)

The US economy has officially been in recession since February. But what we’ve seen so far looks very different from the kind of recessions we’re used to, both because of the unique nature of the coronavirus shock and because of the government response to it. In some ways, the real recession is only beginning now. And if federal stimulus is not restored, it’s likely to be a very deep and prolonged one.

In a normal recession, the fundamental problem is an interruption in the flow of money through the economy. People or businesses reduce their spending for whatever reason. But since your spending is someone else’s income, lower spending here reduces incomes and employment over there — this is what we call a fall in aggregate demand. Businesses that sell less need fewer workers and generate less profits for their owners. That lost income causes other people to reduce their spending, which reduces income even more, and so on.

Now, a small reduction in spending may not have any lasting effects — people and businesses have financial cushions, so they won’t have to cut spending the instant their income falls, especially if they expect the fall in income to be temporary. So if there’s just a small fall in demand, the economy can return to its old growth path quickly. But if the fall in spending is big enough to cause many workers and businesses to cut back their own spending, then it can perpetuate itself and grow larger instead of dying out. This downward spiral is what we call a recession. Usually it’s amplified by the financial system, as people who lose income can’t pay their debts, which makes banks less willing or able to lend, which forces people and businesses that needed to borrow to cut back on their spending. New housing and business investment in particular are very dependent on borrowed money, so they can fall steeply if loans become less available. That creates another spiral on top of the first. Or in recent recessions, often it’s the financial problems that come first.

But none of that is what happened in this case. Businesses didn’t close because there wasn’t enough money flowing through the economy, or because they couldn’t get loans. They closed because under conditions of pandemic and lockdown they couldn’t do specific things — serve food, offer live entertainment, etc. And to a surprising extent, the stimulus and unemployment benefits meant that people who stopped working did not lose income. So you could imagine that once the pandemic was controlled, we could return to normal much quicker than in a normal recession.

That was the situation as recently as August.

The problem is that much of the federal spending dried up at the end of July. And that is shifting the economy from a temporary lockdown toward a self-perpetuating fall in incomes and employment.

One way we see the difference between the lockdown and a recession is the industries affected. The biggest falls in employment were in entertainment and recreation and food service, which are industries that normally weather downturns pretty well, while construction and manufacturing, normally the most cyclical industries, have been largely unaffected. Meanwhile, employment in health and education, which in previous recessions has not fallen at all, this time has declined quite a bit.¹

If we look at employment, for instance which is normally our best measure of business-cycle conditions, we again see something very different from past recessions. Total employment fell by 20 million in April and May of this year. In just two months, 15 percent of American workers lost their jobs. There’s nothing remotely comparable historically — more jobs were lost in the Depression, but that was a slow process over years not just two months. The post-World War II demobilization was the closest, but that only involved about half the fall in employment. So this is a job loss without precedent.

Since May, about half of those 20 million people have gone back to work. We’re about 10 million jobs down from a year ago. Still, that might look like a fairly strong recovery.

But in the spring, the vast majority of unemployed people described themselves as on temporary layoff — they expected to go back to their jobs. The recovery in employment has almost all come from that group. If we look at people who say they have lost their jobs permanently, that number has continued to grow. Back in May, almost 90 percent of the people out of work described it as temporary. Today, it’s less than half. Business closings and layoffs that were expected to be temporary in the spring are now becoming permanent. So in a certain sense, even though unemployment is officially much lower than it was a few months ago, unemployment as we usually think of it is still rising.

We can see this even more dramatically if we look at income. Most people don’t realize how large and effective the stimulus and pandemic unemployment insurance programs were. Back in the spring, most people — me included — thought there was no way the federal government would spend on the scale required to offset the hob losses. The history of stimulus in this country — definitely including the ARRA under Obama — has always been too little, too late. Unemployment insurance in particular has historically had such tight eligibility requirements that the majority of people who lose their jobs never get it.

But this time, surprisingly, the federal stimulus was actually big enough to fill the hole of lost incomes. The across-the-board $600 per week unemployment benefit reached a large share of people who had lost their jobs, including gig workers and others who would not have been able to get conventional UI. And of course the stimulus checks reached nearly everyone. As a result, if we look at household income, we see that as late as July, it was substantially above pre-recession levels. This is a far more effective response than the US has made to any previous downturn. And it’s nearly certain that the biggest beneficiaries were lower-wage workers.

We can see the effects of this in the Household Pulse surveys conducted by the Census. Every week since Mach, they’ve been asking a sample of households questions about their economic situation, including whether they have enough money to meet their basic needs. And the remarkable thing is that over that period, there has been no increase in the number of people who say they can’t pay their rent or their mortgage or can’t get enough to eat. About 9 percent of families said they sometimes or often couldn’t afford enough to eat, and about 20 percent of renters said they were unable to pay the last month’s rent in full. Those numbers are shockingly high. But they are no higher than they were before the pandemic.

To be clear – there are millions of people facing serious deprivation in this country, far more than in other rich countries. But this is a longstanding fact about the United States. It doesn’t seem to be any worse than it was a year ago. And given the scale of the job loss, that is powerful testimony to how effective the stimulus has been.

But the stimulus checks were one-off, and the pandemic unemployment insurance expired at end of July. Fortunately there are other federal unemployment supplements, but they are nowhere as generous. So we are now seeing the steep fall in income that we did not see in the first five months of the crisis.

That means we may now be about to see the deep recession that we did not really get in the spring and summer. And history suggests that recovery from that will be much slower. If we look at the last downturn, it took five full years after the official end of the recession for employment to just get back to its pre-recession level. And in many ways, the economy had still not fully recovered when the pandemic hit.

One thing we may not see, though, is a financial crisis. The Fed is in some ways one of the few parts of our macroeconomic policy apparatus that works well, and it’s become even more creative and aggressive as a result of the last crisis. In the spring, people were talking about a collapse in credit, businesses unable to get loans, people unable to borrow. But this really has not happened. And there’s good reason to think that the Fed has all the tools they need if a credit crunch did develop, if some financial institutions to end up in distress. Even if we look at state and local governments, where austerity is already starting and is going to be a big part of what makes this recession severe, all the evidence is that they aren’t willing to borrow, not that they can’t borrow.

Similarly with the stock market — people think it’s strange that it’s doing well, that it’s delinked from the real economy, or that it’s somehow an artificial result of Fed intervention. To be clear, there’s no question that low interest rates are good for stock prices, but that’s not artificial — there’s no such thing as a natural interest rate.

More to the point, by and large, stocks are doing well because profits are doing well. Stock market indexes dominated by a small number of large companies, and many of those have seen sales hold up or grow. Again, so far we haven’t seen a big fall in total income. So businesses in general are not losing sales. What we have seen is a division of businesses into winners and losers. The businesses most affected by the pandemic have seen big losses of sales and profits and their share prices have gone down. But the businesses that can continue to operate have done well. So there’s nothing mysterious in the fact that Amazon’s stock price, for instance, has risen, and there’s no reason to think it’s going to fall. If you look at specific stocks, you see that by and large the ones that are doing well, the underlying business is doing well.

This doesn’t mean that what’s good for the stock market is good for ordinary workers. But again, that’s always been true. Shareholders don’t care about workers, they only care about the flow of profits their shares entitle them to. And if you’re a shareholder in a company that makes most of its sales online, that flow of profits is looking reasonably healthy right now.

So going forward, I think the critical question is whether we see any kind of renewed stimulus. If we do, it’s still possible that the downward income-expenditure spiral can be halted. At some point soon that will be much harder.