The "Natural" Interest Rate

[moda0306]

A lot of banter happens here about "artificially low" interest rates generated by today's current fed easing.

I know a lot of people here hate Paul Krugman, and a lot of times I think he's way off base, but he had a pretty good blog post here:

(http://krugman.blogs.nytimes.com/2014/0 ... =Body&_r=0)


The gist is, there are different theories on what the "natural" rate of interest are. 

- One theory states that it is whatever rate generates full employment.

- Another states that it is whatever generates low price level increases of goods and services (easier to say "Inflation," but we have some difinitional issues there haha)


- But Paul points out that  there seems to be a third based on history and "asset prices."

So what are the people complaining about artificially low rates talking about? Partly that they’re low by historical standards — but there are enough changes in the landscape, from deleveraging to demography, that this isn’t a convincing argument. But the main thing, I think, is those asset prices, which the advocates of tight money think are too high — because they wouldn’t make sense without those “artificially low”? interest rates.

In case you haven’t noticed, this is a completely circular argument. Once you accept the possibility that rates belong where they are, or even a bit lower, to correspond to the Wicksellian natural rate, you also conclude that asset prices might make sense; and once you concede that asset prices might make sense, you lose the supposed evidence that rates are all wrong.

He makes a point that I've basically tried and failed to make... that the argument that "asset prices being high" means that interest rates are artificially low is circular.  High asset prices are the natural result of low interest rates, as a matter of math.  If interest rates belong where they are, then asset prices belong where they are.  We've got a stock market with earnings ratios in the 4-5% range (on average), and a treasury bond market ranging from 0%-3.5% about.  In an environment of 1) deleveraging (or lack of robust re-leveraging), 2) demographic shifts, 3) low inflation, and 4) high unemployment, it makes all the sense in the world to have interest rates like this.

Saying that "asset prices are too high" right now is like saying "asset prices were too low" in 1981 and that we needed inflation.  There is a decent argument that the fed raised rates too hard in 1981, but "asset prices being too low" was hardly part of it.  It's almost all about inflation of the general price level of goods & services, and unemployment (when I say unemployment, I implicitly include underemployment, workforce participation, etc as key factors as to whether we are "at full capacity.")

Sound off... perhaps this is a bit of a distraction and redundant to hundreds of debates so far, but I thought this was a good way of putting it.  It's a circular argument.  Income-producing asset prices are just another function of interest rates.  A perfectly natural function, at that.  If the rate is looking like it is "natural," due to other indicators, then so are those prices.

[Kshartle]

This (like so many other things) is really a discussion of the use of force.

Interest rates are artificially low or high if the use of force is being employed to raise or lower them, it's that simple. It appears that force is being used to manipulate them lower currently and I think the only credible argument can be made that this is the case.

That being said we always have artificial rates and we never have market rates. The closet thing we can get is the market trying to guess the next wave of manipulation and adjusting to it, but this is certainly not a reflection of what would be the true rate.

In fact, if we had voluntary money instead of fiat we might have a much lower rates, maybe as low as 1% on a AAA 30 year bond.....who knows? We can only say they are lower or higher than they are currently if we removed X variable of force.

[Kshartle]

A "real" or "correct" interest rate would be one that is voluntarily agreed upon by all partcipants. It wouldn't invlove counterfieting or other price fixing using force.

It would also really require voluntary money.

Krugman, as usual, doesn't understand a whit of economics.

[moda0306]

A "real" or "correct" interest rate would be one that is voluntarily agreed upon by all partcipants. It wouldn't invlove counterfieting or other price fixing using force.

It would also really require voluntary money.

Krugman, as usual, doesn't understand a whit of economics.

I guess very few economists do, then.  As I've never heard your argument outside of fringe anarchist circles.

Maybe... just maybe... the use of force is simply a very important aspect of economics, and you lose all perspective on how it works within models when you see it exist within them .

[moda0306]

A "real" or "correct" interest rate would be one that is voluntarily agreed upon by all partcipants. It wouldn't invlove counterfieting or other price fixing using force.

It would also really require voluntary money.

Krugman, as usual, doesn't understand a whit of economics.

I guess very few economists do, then.  As I've never heard your argument outside of fringe anarchist circles.

Maybe... just maybe... the use of force is simply a very important aspect of economics, and you lose all perspective on how it works within models when you see it exist within them .

For instance, a threat of force to accept a certain interest rate IF you choose to invest with the government qualifies as "force."

So does genocide.

However, they both have very, very different affects on our economic decisions.  I'm far less interested in figuring out if a force, threat of force, or potential force is "wrong" or "right," so much as I want to know how it affects economics (out of interest), and my life-strategy (out of selfishness).

[Pointedstick]

There is no such thing as a "natural rate of interest." Interest rates are no more "natural" than are skyscrapers or the internet. They are a human monetary invention. As such, they will tend to reach equilibrium at different points in different situations, depending on a whole host of factors: unemployment, inflation, what the central bank is doing, etc. It is always being "manipulated" by some force or group or other.

[Kshartle]

A "real" or "correct" interest rate would be one that is voluntarily agreed upon by all partcipants. It wouldn't invlove counterfieting or other price fixing using force.

It would also really require voluntary money.

Krugman, as usual, doesn't understand a whit of economics.

I guess very few economists do, then.  As I've never heard your argument outside of fringe anarchist circles.

Maybe... just maybe... the use of force is simply a very important aspect of economics, and you lose all perspective on how it works within models when you see it exist within them .

it is an important componenet. That's why I include it. Krugman ignores it, because he doesn't understand economics.

If I tell you to loan me 100 bucks for one year at 3% interest otherwise I will shoot you, P.K. would say he has no idea if that rate is high or low. 

[Kshartle]

There is no such thing as a "natural rate of interest." Interest rates are no more "natural" than are skyscrapers or the internet. They are a human monetary invention. As such, they will tend to reach equilibrium at different points in different situations, depending on a whole host of factors: unemployment, inflation, what the central bank is doing, etc. It is always being "manipulated" by some force or group or other.

Yes exactly, until we stop using force against each other to solve our problems.

The point is it's pretty obvious that direct intervention via the use of force is being used to lower rates currently. At least it appears obvious to me that this is the case.

[Pointedstick]

The point is it's pretty obvious that direct intervention via the use of force is being used to lower rates currently. At least it appears obvious to me that this is the case.

Even if any given interest rate is allowed to reach an equilibrium point without any government entity forcing it up or down, that will still not be a "natural" rate; that's my point. It may be the equilibrium rate, but it's no more natural than we would say that the equilibrium of supply and demand in the automobile industry represents the "natural price of a car."

[Mountaineer]

There is no such thing as a "natural rate of interest." Interest rates are no more "natural" than are skyscrapers or the internet. They are a human monetary invention. As such, they will tend to reach equilibrium at different points in different situations, depending on a whole host of factors: unemployment, inflation, what the central bank is doing, etc. It is always being "manipulated" by some force or group or other.

Yes exactly, until we stop using force against each other to solve our problems.

The point is it's pretty obvious that direct intervention via the use of force is being used to lower rates currently. At least it appears obvious to me that this is the case.

That should be completely easy.  Just eliminate sin.  There you have it my friend.  The solution to your NAP issue.  Perhaps after the morality proof is in well in hand, you can prove sin (and/or absence of sin) without using any superstitious methods. 

... Mountaineer

[Kshartle]

The point is it's pretty obvious that direct intervention via the use of force is being used to lower rates currently. At least it appears obvious to me that this is the case.

Even if any given interest rate is allowed to reach an equilibrium point without any government entity forcing it up or down, that will still not be a "natural" rate; that's my point. It may be the equilibrium rate, but it's no more natural than we would say that the equilibrium of supply and demand in the automobile industry represents the "natural price of a car."

What would you call a "natural" rate then PS? What would it be other than a rate(s) derived from voluntary consent?

I suppose we could say that making a loan is deferring consumption into the future. So the rate should naturally be the additional value required by someone to defer their consumption and would factor in productivity increases that (absent force disruption) should lower prices in the future. The result though will always be a market price that is created by all the players and all their transactions. Every single new transaction will be unique but will contribute to the price (rate) of the next loan, even if the circumstances are drastically different.

There are lots of factors that influence individual transactions and thus interest rates. They are all "natural" except for force in that they are all based on the concept of value exchange and win-win transactions. When force is introduced we can't know for certain what the rate would be because it being set by a concept other than win-win exchange. That is the distinction. Unless you can think of another 

[Pointedstick]

What would you call a "natural" rate then PS? What would it be other than a rate(s) derived from voluntary consent?

I would not and do not use the term. I think it is meaningless economic gibberish that economists came up with to make themselves sound smart. To me, something cannot be natural unless it actually exists in a state of nature. I think it is nonsensical to say something is natural when it clearly a result of human invention or social interaction. Gravity is natural. Entropy is natural. Life and death are natural. Interest rates and bonds and money and automobiles and vacations to Disneyland are not. 

[Xan]

On the Last Day, God will wipe away every tear, and all interest rates will be natural.

[moda0306]

Nobody's holding a gun to your head that you have to loan your money to anyone at any rate.  You earn money (presumably in dollars) which are assets that you can either hold under a matress @ 0%, keep in a bank @ .1%, keep in government bonds at 0%-3.5%, keep in corporate bonds at 3%-5%, or just sell to someone for something of a more intrinsic value.

Now if that asset rises in value, and you sell it, depending on how you hold it, you might have to pay some of your gains in taxes.  And those have a gun associated with them .  But nobody is forcing you to loan anyone money.  Let's be clear about how the force is being applied... otherwise we're going to get nowhere, and we'll always have the wrong strategic response.

That's where your problem lies... you description of the nature of the force we are being subject to obfuscates reality.  PK understands force, or at least some of the indicators of "manipulated" markets... that's why he creates and/or refers to models on how governments interact with markets. 

But keep in mind, you don't just disagree with him... you disagree with almost all economists.  Almost. All. Economists.

[Kshartle]

What would you call a "natural" rate then PS? What would it be other than a rate(s) derived from voluntary consent?

I would not and do not use the term. I think it is meaningless economic gibberish that economists came up with to make themselves sound smart. To me, something cannot be natural unless it actually exists in a state of nature. I think it is nonsensical to say something is natural when it clearly a result of human invention or social interaction. Gravity is natural. Entropy is natural. Life and death are natural. Interest rates and bonds and money and automobiles and vacations to Disneyland are not. 

Are humans not natural?

[Xan]

What would you call a "natural" rate then PS? What would it be other than a rate(s) derived from voluntary consent?

I would not and do not use the term. I think it is meaningless economic gibberish that economists came up with to make themselves sound smart. To me, something cannot be natural unless it actually exists in a state of nature. I think it is nonsensical to say something is natural when it clearly a result of human invention or social interaction. Gravity is natural. Entropy is natural. Life and death are natural. Interest rates and bonds and money and automobiles and vacations to Disneyland are not. 

Are humans not natural?

Are governments?

[Mountaineer]

This discussion is almost better than the "natural" foods section of the supermarket.  Natural is one of those meaningless, non-specific words that means something different to everyone.  Personally, I think it is the natural nature of a naturalist to ponder bellybuttons.  Of.  Gorillas.  And.  Crocodiles.  And.  Themselves. 

... Mountaineer

[Kshartle]

Nobody's holding a gun to your head that you have to loan your money to anyone at any rate.  You earn money (presumably in dollars) which are assets that you can either hold under a matress @ 0%, keep in a bank @ .1%, keep in government bonds at 0%-3.5%, keep in corporate bonds at 3%-5%, or just sell to someone for something of a more intrinsic value.

Now if that asset rises in value, and you sell it, depending on how you hold it, you might have to pay some of your gains in taxes.  And those have a gun associated with them .  But nobody is forcing you to loan anyone money.  Let's be clear about how the force is being applied... otherwise we're going to get nowhere, and we'll always have the wrong strategic response.

That's where your problem lies... you description of the nature of the force we are being subject to obfuscates reality.  PK understands force, or at least some of the indicators of "manipulated" markets... that's why he creates and/or refers to models on how governments interact with markets. 

But keep in mind, you don't just disagree with him... you disagree with almost all economists.  Almost. All. Economists.

Moda,

I don't have to loan out money. But if I choose to loan out money it will be at the prevailing interest rate for a given risk level and maturity and other factors. That rate however is not a pure function of voluntary exchanges.

Look, if i ask you for you a dollar and you give it to me or if I trade you a pen for it do you understand the difference between that and me ordering you to give it to me at gunpoint? In the latter instance your reaction is not the natural win-win value exchange but a market distortion through violent threat.

What reality have I "obfuscated"? I have described reality. PK ignores it and pretends certain factors don't exist. His article is poorly written and nonsensical that again I can't beleive it's an accident. It has to be intentionally dumb. There is no logic to it, no point/thesis and no conclusion. It's just a stream of loosely related thoughts and strawman arguments.

He says people look at the high prices and say it's a function of rates being held too low by force (he calls it policy) and they say it's terrible. Then he says a rate is only too low if it results in accelerating inflation which of course he doesn't see so the rate must not be too low (but I thought he advocated inflation?).

Then he says maybe rates are low when they are low compared to historical norms. Now this is obviously the case but Krugaman says that they should be low anyway because of demographics so he doesn't think that argument makes sense either.

Next this genius says since he doesn't see TV shows about horse-flipping and says that CNBC viewership is plummeting so that proves there's no wild exhuberance driven by cheap money.

He concludes that there is no macroeconomic case for "wildly" depressed rates (strawman and moving the goal posts) and not much reason to think assets are overvalued (overpriced).

Sheer brilliance that he has taken zero economic understanding and an expertise in false arguments and nonsensical blather and made a career of it. Maybe he is smart in some fashion in that he has duped people but then perhaps he just has no scruples and he's picked easy targets to dupe. 


Also appeal to authority is a false argument so.......

[moda0306]

What would you call a "natural" rate then PS? What would it be other than a rate(s) derived from voluntary consent?

I would not and do not use the term. I think it is meaningless economic gibberish that economists came up with to make themselves sound smart. To me, something cannot be natural unless it actually exists in a state of nature. I think it is nonsensical to say something is natural when it clearly a result of human invention or social interaction. Gravity is natural. Entropy is natural. Life and death are natural. Interest rates and bonds and money and automobiles and vacations to Disneyland are not. 

I think "natural" interest rates are those that are not manipulated prices too far from what it would be without the manipulation.  Just because a government controls a certain market doesn't mean we get to just scream at it as evil... it actually helps to look at what it is actually doing to the market.

One way to indicate if there is an "unnatural" price of something is to look at whether there are shortage or surplus indicators... If the government set an artificially low price of most general market goods, you will have a shortage.  Corn, for instance.  If the government came in and basically said that retailers could NOT sell corn for more than 10 cents per ear of corn, there would be a huge shortage of corn for human consumption, as corn (and eventually cropland) got used for different purposes.

Likewise, if interest rates are grossly artificially low, one would expect certain things... a huge boom in lending, and therefore investment, and likely consumption, and therefore inflation.  People would rather hold tangible or increasing-income goods rather than cash and/or bonds. 

If interest rates are grossly artificially high, then we'd expect the opposite.  A lot of people trying to save rather than spend, investment not occurring due to oppressively high interest rates, low velocity of money.  Perhaps more barter, since money is too lucrative to hold on to...

You hear claims of artificial prices, but none of the typical economic indicators are telling us that they're artificial, and all the government is doing is putting a floor on the cost of lending... not dictating the rate that it occurs at out in the free-ish market. 

The government has set up some weird rules to the game, but they don't force you to play, in ways that force you into a corner.  You can index your contracts to inflation.  You can sell your cash for other forms of money/investment/savings.  You can even barter.  Yes, a court will demand payments in our legal tender, but if you agree to an arbitrator in most contracts, you may be able to avoid courts in many circumstances.

[Kshartle]

This discussion is almost better than the "natural" foods section of the supermarket.  Natural is one of those meaningless, non-specific words that means something different to everyone.  Personally, I think it is the natural nature of a naturalist to ponder bellybuttons.  Of.  Gorillas.  And.  Crocodiles.  And.  Themselves. 

... Mountaineer

The word carries a lot of different meanings to different people so to that end Xan I don't know how to say if governments are natural or not.

I think when people refer to the natural rate of interest vs. a non-natural rate they can only mean one thing.......the rate the market would set vs. the rate the government sets. It's the rate that people would voluntarily settle on vs. the rate determined by the threat of violence. We can only guess at the former, but I think there are ample signals when the latter is pushing rates higher or lower than they would be absent the pushing.

[Mountaineer]

This discussion is almost better than the "natural" foods section of the supermarket.  Natural is one of those meaningless, non-specific words that means something different to everyone.  Personally, I think it is the natural nature of a naturalist to ponder bellybuttons.  Of.  Gorillas.  And.  Crocodiles.  And.  Themselves. 

... Mountaineer

The word carries a lot of different meanings to different people so to that end Xan I don't know how to say if governments are natural or not.

I think when people refer to the natural rate of interest vs. a non-natural rate they can only mean one thing.......the rate the market would set vs. the rate the government sets. It's the rate that people would voluntarily settle on vs. the rate determined by the threat of violence. We can only guess at the former, but I think there are ample signals when the latter is pushing rates higher or lower than they would be absent the pushing.

I thought governments do not exist.  Forrests do not exist.  Trees exist.  People exist .... or do they? 

... Mountaineer

[moda0306]

Nobody's holding a gun to your head that you have to loan your money to anyone at any rate.  You earn money (presumably in dollars) which are assets that you can either hold under a matress @ 0%, keep in a bank @ .1%, keep in government bonds at 0%-3.5%, keep in corporate bonds at 3%-5%, or just sell to someone for something of a more intrinsic value.

Now if that asset rises in value, and you sell it, depending on how you hold it, you might have to pay some of your gains in taxes.  And those have a gun associated with them .  But nobody is forcing you to loan anyone money.  Let's be clear about how the force is being applied... otherwise we're going to get nowhere, and we'll always have the wrong strategic response.

That's where your problem lies... you description of the nature of the force we are being subject to obfuscates reality.  PK understands force, or at least some of the indicators of "manipulated" markets... that's why he creates and/or refers to models on how governments interact with markets. 

But keep in mind, you don't just disagree with him... you disagree with almost all economists.  Almost. All. Economists.

Moda,

I don't have to loan out money. But if I choose to loan out money it will be at the prevailing interest rate for a given risk level and maturity and other factors. That rate however is not a pure function of voluntary exchanges.

Look, if i ask you for you a dollar and you give it to me or if I trade you a pen for it do you understand the difference between that and me ordering you to give it to me at gunpoint? In the latter instance your reaction is not the natural win-win value exchange but a market distortion through violent threat.

K,

Every single market is manipulated in some manner by human force upon another.  Hell, home security systems are built on it .  Does that mean someone is holdng a gun to your head FORCING you to buy a home security system?

No.

This is your obfuscation of reality.  Nobody is forcing you to participate in a certain market.  In fact, like I've said, you can participate in markets that are far-more tangible, and some (gold) that actually benefit in real terms from artificially low interest rates.


His arguments aren't straw men.  You have to realize he's talking about a HUGE majority of supply-side economic thinking.  It might be a straw-man if he was talking about anarchists.  He's not.  He's talking about conservative economists.

His examples were a little silly, but there is not a whole lot of "irrational exuberance.  Where is all this wild investment happening?  Home prices have calmed way down in the last few months since recovering sharply.  Right-wing economists DO think that rates are "wildly" depressed.  This is no straw-man.

You obviously simply don't read much economic thought besides "anarchism vs statist control."  Can you please point me to some of the economists you like to follow.  Writings you find interesting?


PK advocates raising the inflation target to 3% or maybe 4%.  Nothing earth-shattering.  It IS his position, that inflation and full employment help indicate whether interest rates are "natural," and that he's identified a supply-side analysis that uses a combination of historical rates and "asset prices" as their analytical foothold (and they do... this is NOT a strawman as I can tell).


I'm also not really appealing to authority.  It isn't correct just because he says it is.  What he does is accurately pose two more-conservative opinions on what the natural interest rate indicators are (sorry he left out the 1% of anarchists out there that use force as a general indicator that savers are getting screwed).  I didn't want to pose his mini-analysis as my own.  That would be a bit slimy of me.  I give credit where credit is due.




But back to my earlier question, who do you follow in terms of economic theory!?  I surely don't follow everything PK says, but some of his analysis is logical and spot-on.  He often correctly sums up conservative economic thought, and shows why the market isn't bearing out what they think is true.

And this is why he has correctly predicted that interest rates AND inflation would stay low into 2014, while Peter Schiff thought the world would end in 2010... errr 2011.... make that 2012.... SOMEDAY DAMMIT!!

[Kshartle]

I think "natural" interest rates are those that are not manipulated prices too far from what it would be without the manipulation. 
I have to be a stickler here that saying "too far" is moving the goal posts. What is "too far" enough to constitute manipulation. Manipulation is manipulation regardless of "how far" anyone considers it.

Likewise, if interest rates are grossly artificially low, one would expect certain things... a huge boom in lending, and therefore investment, and likely consumption, and therefore inflation.  People would rather hold tangible or increasing-income goods rather than cash and/or bonds. This is not a good way to determine if rates are too low. You don't know if in the absence of manipulated rates that lending wouldn't be collapsing and prices plummeting. Just because lending isn't booming and we aren't getting 15% increases in the price level doesn't mean rates aren't artificually low. This is faulty logic. You are assuming a certain outcome from artifically low rates and exluding other outcomes that could be just as valid

[moda0306]

Let's not forget that the U.S. government implicitly (via the FDIC) and explicitly (via federal loan guarantees) makes saving money at interest "artifiically safe."

In a real anarchist paradise, as K has essentially admitted, you could be subject to extremely low interest rates, because storing and insuring your gold might just break you even at zero if you wanted to also enter it into a fractional-reserve system.

So there ARE artificial aspects entering the system, but from both ends in terms of cost/benefits to savers.  Once again... certain economc indicators should tell us whether rates are artificially high or low. 

And anarchists, as well as a lot of conservative supply-siders, don't want to admit that they aren't telling us the story that they'd like them to be.

[Kshartle]

But back to my earlier question, who do you follow in terms of economic theory!? 

I don't read much anymore from "economists" but in the past it's been Browne, Schiff, Von Mises, Hyaek.

I can't think of many others. I just bought "The Wealth of Nations" on kindle. haven't started it though.

I am 50% done with "The law" from Bastiat, having purchased it over the weekend also.

The kindle is awesome to anyone who doesn't have one.