The International Economy

At The International Economy: Low Interest Rates Were OK

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s roundtable was on concerns that ultra-low interest rates after the 2007-2009 financial crisis contributed to rising inequality and asset bubbles, and asked contributors to grade post-2007 monetary policy on a scale of A to F.)

Overall, I give the negative interest rate experiment a grade of B. The costs of negative rates have been greatly exaggerated. But so have the benefits. The main lesson is that conventional monetary policy is surprisingly weak in a depressed economy, even when carried to extremes. The next time we need stimulus, greater weight should be put on fiscal policy.

The case against ultra-low rates on distribution grounds is not very strong, in my view. Yes, low rates do tend to raise asset values, and it’s the rich who own most of the assets. But we should not make the mistake so many people do, and confuse a change in the present value of future income streams with a change in those streams themselves. Low rates, for example, imply a greater present value of the same future dividend payments, and thus higher stock prices. But that has no effect on income distribution — the owners of the stock are receiving the same payments as they were before.

The bigger criticism of ultra-low rates is that they didn’t have much effect one way or another. Did 20 years of zero nominal rates in Japan significantly boost demand and growth? It doesn’t seem like it.

At the same time, we should be careful of language like “distortion,” which suggests that there is some true, natural level of interest rates and investment. Whether high or low, interest rates are always set by policy. And this always involves tradeoffs between competing social goals.

Whether ultra-low rates contribute to bubbles is debatable. Many of the world’s great bubbles — from the 1920s in the US to the 1990s in Sweden — have occurred in environments of high interest rates. But let’s say for the sake of argument that cryptocurrency is socially useless, and that it would never have taken off if rates were higher. Is this a problem with negative rates? Or is it a problem with the financial system? The reason we have so many well-educated, well-compensated people working in finance is that they are supposed to direct credit to the best opportunities. If cheap money leads them to invest in projects that are worthless, or worse, rather than ones with moderate returns, they’re not doing their jobs.

If jet fuel were free, we would all probably fly more. But if planes kept crashing into the ocean, we’d blame the airlines, not the cheap fuel.

Speaking of airlines, it’s easy in retrospect to see the subsidized loans to them and other pandemic-hit industries as excessive. But we don’t know what the counterfactual is — it’s possible that without public support, they would have collapsed into bankruptcy, leading to a much slower recovery. Certainly we couldn’t be sure at the time. Under the extraordinary circumstances of the pandemic, there was no safe course, only a balance of risks. The high inflation of 2021-2022 was unfortunate; a prolonged depression would have been much worse. Perhaps next time — and climate change ensures that there will be a next time — we will strike a better balance. But it seems to me that under the circumstances, policymakers did pretty well.

That’s what I wrote for the symposium. Let me add a couple of things here.

First, this is not a new debate. Many of the same arguments were being made immediately after the global financial crisis, and even before it in the mid-2000s, in the context of the supposed global savings glut. At that time, the idea was that the volume of excess savings in Asia were too great to be absorbed by productive investment in the US and elsewhere, leading to downward pressure on interest rates and an excess of speculative investment, in housing especially.

It’s progress, I suppose, that the more recent period of low interest rates is attributed straightforwardly to central banks, as opposed to an imagined excess of “saving.” (For a critique of the savings-glut story, you can’t do better than Jörg Bibow’s excellent work.) But the more fundamental problem remains that the savings-glut/too-low-for-too-long stories never explain how they coexist with all the other economic stories in which more abundant financing is unambigously a good thing. As I wrote a dozen years ago¹:

the savings glut hypothesis fails to answer two central, related questions: Why was there a lack of productive investments available to be financed, and why did the financial system fail to channel the inflow of savings in a sustainable way? From a Keynesian perspective, there is nothing strange about the idea of a world where savings rates are chronically too high, so that output is demand-constrained; but this is not the perspective from which the savings-glut hypothesisers are arguing. In other contexts, they take it for granted that an increase in the savings rate will result in greater investment and faster growth.

In particular, as I pointed out there, many of the same people arguing for these stories also think that it is very desirable to reduce government budget deficits. But if you ask any economist what is the economic benefit of moving the government balance toward surplus, their answer will be that it frees up saving for the private sector; that is, lower interest rates.²

Second. Returning to the International Economy roundtable, it’s striking how many of the contributors shared my basic analysis³ — ultra-low rates didn’t achieve very much, but they were better than nothing given the failure of the budget authorities to undertake adequate stimulus. It’s interesting is that people with this same analysis — and who also reject the idea that the low rates of the 2010s are to blame for the inflation of the early 2020s — give such different responses on the grading component. I agree with everything that Jamie Galbraith writes, and especially appreciate his points that hardly any private borrowers ever faced zero (let alone negative) rates, and that higher rates do not seem to have done much to curb speculative excess. (Just look at “AI”.) I also agree with everything Heiner Flassbeck says (especially the underappreciated point that we’ve also had a decisive test of the benefits of wage flexibility, with negative results) and with almost everything Brigitte Granville says. Yet two of us give As and Bs, and two give Ds and Fs. It’s the difference between comparing monetary policy’s actual performance to what it reasonably could have accomplished, and to what it promised, perhaps.

Finally. It might seem strange to see me speaking so positively about macroeconomic policy over the past decade. Aren’t I supposed to be a radical of some sort?⁴ It was even a bit disconcerting to me to see I typed those words a few months ago (there’s a bit of turnaround time with these things), given that my main feelings about Western governments these days tend toward rage and disgust.

But the point here is important. It’s important to remember that the central macroeconomic problem in recent years has been insufficient demand.⁵ It’s important to remind people of the overwhelming evidence, and the quite broad consensus, that the economic problem over the past 15 years has not been a lack of real resources, but a lack of spending — of demand. (A world in which over-low interest rates could even be a concern, is not a world where the central economic problem is scarcity.) And I think that it’s true, and important, that the institutions — at least in the US and Western Europe — that were consistently trying to address this problem, were the central banks.

Even today, while we can certainly argue that central banks raised rates too aggressively, the main contractionary pressure is coming from elected governments. This is most obvious in Europe, but in the US, it seems to me, the withdrawal of pandemic unemployment benefits and the child tax credit have done more harm than anything the Fed has done. There’s an old idea that elected governments are structurally biased toward deficits and generous social benefits.⁶ But it’s clear this is no longer true, if it ever was.

Against this background, I think both the broader recognition of hysteresis and chronic demand shortfalls in the 2010s, and the aggressive response to the pandemic in this decade, are positive lessons that need to be preserved and defended and built upon. It’s very challenging to separate this positive record on domestic economic policy from the increasingly horrifying treatment of the rest of the world that we have seen from the same governments. (I make this argument in the context of industrial policy in a forthcoming piece in Dissent.) But I think it’s vitally important, both politically and analytically, that we continue to try to do so.

At the International Economy: What’s Wrong with Abundant Liquidity?

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was the possible dangers of “today’s giant swirling ocean of liquidity”.)

Imagine a city that experiences a miraculous improvement in its transit system. Thanks to some mix of new technologies and organizational improvements, the subways and buses are now able to carry far more passengers at lower cost and the same level of service. Would we see that as good news, or as bad? It’s true that Uber drivers and gas station owners would be unhappy as abundant public transportation reduced demand for their services. And retailers and restaurants might face challenges in managing a sudden flood of new customers. But no one, presumably, would think the city should deliberately give up the improvements and return transit service back to its old level.

The point of this little fable should be obvious: liquidity, like transportations services, is useful. Having more of it is better than having less.

What liquidity is useful for, fundamentally, is making promises. It functions as a kind of collective trust. The world is full of socially useful projects that can’t be carried out because even a well-grounded expectation of future benefits can’t be turned into a claim on resources today. Liquidity is the fuel for these transactions. In a world of abundant credit and low interest rates, it’s easier for me to turn my future income into ownership of a home, or a business to turn future profits into new plant and equipment, or a government to turn future revenue into improved public services.

Someone with a great business plan but no capital of their own might try to get the labor and inputs they need to bring it about by promising workers and vendors a share in the profits. Unless the business can be launched with just the resources of immediate family and friends, though, it’s not likely to get off the ground this way. The role of the bank is to allow strangers, and not just those who already know and trust each other, to contribute to the plan, by accepting — after appropriate scrutiny — the entrepreneur’s promise, and offering its own generally-negotiable promise to the suppliers of labor and other resources.

Yes, when you make it easier to make promises, some of them won’t pan out. But we would like people to make more provision for future needs, not less, even if our knowledge of those needs is less than perfect. The most dynamic parts of the economy are the ones where there are the most risky projects, some of which inevitably fail.

Of course asset owners are unhappy about lower yields. But that’s no different from the complaints we always hear from incumbents when production improvements make something cheaper. Asset owners’ complaints are no more reason to deny us the socially useful services of liquidity than those of the proverbial buggy-whip makers were to deny us the services of cars. (Less reason, actually, given the concentration of financial wealth among the wealthiest families and institutions.)

Interest rates today are lower than at almost any time in history. So are the prices of food or clothing. We should see abundant liquidity the same way we see these other forms of abundance — as the fruit of the technological and institutional that has made us so much materially richer than our ancestors.

At The International Economy: How Worried Should We Be about Asset Bubbles?

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was “What about the Risk of a Bursting Asset Bubble?”, with corporate debt and equity mentioned as possibilities. Contributors were asked to rank their level of concern from 1 to 10. My response is below.)

Any time you have an asset held primarily for capital gains, a story that allows people to extrapolate from recent price increases to future ones, and a reasonably elastic credit system, you have the ingredients for a bubble. The question is not whether there will be bubbles, but how damaging they will be, and what steps we should take if we think one is developing in a particular asset market.

Corporate debt is an unlikely asset for a bubble. Unlike with equity, real estate, or currency, there are clear limits to potential capital gains. High levels of stock buy- backs are problematic for a number of reasons, but they don’t particularly suggest a bubble. When a greater share of corporate value added is paid out to shareholders rather than retained and invested or paid to workers, that may be bad news for the economy in the long run. But it is good news for owners of corporate stock, and there’s nothing strange about it being priced accordingly.

Cryptocurrencies are a better candidate for a bubble. It’s safe to say they are mostly held in expectation of capital gains, since they pay no income and, despite the promises of their boosters, have limited utility for transactions. It wouldn’t be surprising if their value fell to a small fraction of what it is today.

But that brings us to the question of how damaging a bursting bubble will be. The housing bubble was exceptionally damaging because housing is the main asset owned by most middle-class families, housing purchases are mostly debt-financed, and mortgages are a major asset for the financial system. It’s hard to see how a collapse of bitcoin or its peers would have wider consequences for the economy.

The other question is what to do about a bubble if we have reason to believe one is forming. One common answer is to raise interest rates. The problem is that, historically, there’s no sign that low rates are more favorable to bubbles than high ones. The 1980s savings and loan crisis took place in an environment of—indeed was driven by—historically high interest rates. Similarly, Sweden’s great real estate bubble of the late 1980s took place when rates were high, not low.

And why not? While productive investment may be discouraged by high rates, expected capital gains at the height of a bubble are too high for them to have much effect. This was most famously illustrated in the late 1920s, when the Fed’s efforts to rein in stock prices by raising rates did a great deal to destabilize European banks by reversing U.S. capital outflows, but had little or no effect on Wall Street.

A better policy in the face of a developing bubble is to directly limit the use of credit to buy the appreciating asset. Tighter limits on mortgage lending would have done far more than higher rates to control the housing bubble of the 2000s.

In other cases, the best policy is to do nothing. As economists going back to John Maynard Keynes have observed, a chronic problem for our economy is an insufficient level of investment in long-lived capital goods and new technology. To the extent that inflated asset values encourage more risky investment—as in the late 1990s— they may be even be socially useful.

By all means, let’s take steps to insulate the core functions of the financial system from speculation in asset markets. But holding macroeconomic policy hostage to fears of asset bubbles is likely to do more harm than good.

Weighing the chance of a major bubble along with its likely consequences, I’d put my concern over asset bubbles at three out of ten. The biggest danger is not a bubble itself, but the possibility that a fear of bubbles will prompt a premature tightening of monetary policy.

Is Productivity Being Undermeasured?

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was: “What are the policy implications if productivity growth is being under-measured in the official data?” My answer is below.)

How many hamburgers equal one haircut?

In itself, the question doesn’t make sense. They’re just different things. What we can compare, is how much they cost. This is true across the board: The only way we can convert all the endlessly varied objects and activities that make up “the economy” into a single number, is through their market prices. Markets are what let us express all the various products of human labor as a single quantity we call output.

This means that productivity is only meaningful in the context of market prices. There are lots of things that people do that are useful, important, even essential to economic life, from raising children to following the law, that can’t be expressed as output per hour.

So it doesn’t really make sense to ask if the nonmarket effects of technological change mean we are undermeasuring productivity. A new technology may transform our lives in all sorts of ways, but we can’t talk about its effect on productivity except insofar as its products are sold. There’s no other basis on which productivity can even be defined – we have to go by market prices. And what market prices are telling us is that productivity growth is slower than it used to be.

This slowdown is not really surprising. Manufacturing – where the transformation of work by technology has gone farthest, and where productivity growth almost always fastest – is steadily shrinking as a share of the economy.

It is true that we often think of economic growth as something broader than market prices. It’s supposed to describe a more general rise in living standards. So a more meaningful way to ask the question might be: Does measured productivity growth accurately reflect the material improvements in people’s lives?

The answer here is indeed no. But unfortunately, in the rich countries at least, the mismeasurement probably goes the opposite way as the question suggests.

Measures like life expectancy used to be closely linked with economic growth. In poor countries, this is still the case – higher GDP is associated with longer lifespans, lower child mortality, and similar improvements in health and wellbeing. If anything, today’s GDP growth may be associated with even faster improvement than we would expect based on the historical record. But in richer countries the opposite is true – higher GDP no longer translates reliably into better health outcomes. In some places – like the UK, and much of the US – life expectancy is actually falling, even as income per capita continues to rise.

Leisure time is another measure of wellbeing — presumably if people were having an easier time meeting their material needs, they would choose to take more time off work. (Adam Smith once suggested that the amount of leisure people enjoyed was the only meaningful standard of economic value across countries.¹) On this measure too, living standards seem to be falling short of GDP growth rather than running ahead of them. Between the end of World War II and the early 1980s, the average weekly hours of an employed American fell by about 15 percent. But since then, average hours per worker have been essentially flat. This makes the postwar growth performance look even better, and the more recent performance worse, than the headline numbers suggest.

It seems likely that measured productivity overstates, rather than understates, our real improvement in living standards, at least in the US. If so, the policy implications seem clear. Policymakers should worry less about growth, and more about concrete interventions that we know improve people’s lives – things like universal access to childcare and health care, high-quality education, and paid time off for all.