Keynes on low interest rates
Whatever the outcome of efforts to resolve severe economic difficulties in Europe and elsewhere, it is becoming increasingly clear that the next big economic crisis may not hinge on interest rates at all. One reason is that the world’s central banks, many of them following something like a Robinsonian “cheap money policy,” have managed to keep interest rates reasonably low in many countries. For example, it seems clear that yields on Spanish and Italian bonds are under control for now, after statements last month by Mario Draghi, the president of the ECB, that he was “ready to do whatever it takes,” to keep interest rates down. As made clear in this interesting and enlightening 2003 book edited by Bell and Nell (Stephanie Bell Kelton and Edward Nell), the theoretical argument for the Eurozone was badly flawed from the beginning. (Indeed, many in the world of heterodox economics saw these flaws from the beginning.) But, returning in this post to a key theme in Joan Robinson’s writings on the interest rate, I will offer some of the thoughts of John Maynard Keynes himself, who wrote in 1945 that:
The monetary authorities can have any rate of interest they like.… They can make both the short and long-term [rate] whatever they like, or rather whatever they feel to be right. … Historically the authorities have always determined the rate at their own sweet will and have been influenced almost entirely by balance of trade reasons [Collected Writings*, xxvii, 390–92, quoted from L.–P. Rochon, Credit, Money and Production, page 163 (publisher book link)].
Here in the United States, the Fed has shown its ability as a liquidity provider to keep interest rates on relatively safe investments very low across the maturity spectrum, despite spending much more than it received in tax payments in calendar years 2009–2011, and presumably the current year. Keynes’s statement, much like the quote from Robinson mentioned above and the one in this earlier post, foretells this outcome.
Hence, recent US experience supports the view that calls for cuts in government spending and/or tax increases cannot be justified by fears that high deficits cause high interest rates at the national or global level.
* Note: The complete set of Keynes’s works is out of print in hardback and will be reissued as a 30-volume set of paperbacks later this fall, according the Cambridge University Press website. – G.H., September 3
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The Fed CAN control both short and long-term interest rates but I don’t believe it is currently choosing to do so. There is evidence that the Fed typically adjusts its short rate in response to market movements on the demand for credit (http://bubblesandbusts.blogspot.com/2012/08/markets-determine-interest-ratesuntil.html). Expectations of future Fed action may therefore be based on the the market perception of future demand for credit, which is currently pretty low. Either way, high deficits would not be the reason for an upwards shift in rates.
Good to get your comment. It can be difficult to come up with a good definition of “control” in the context of economic policy. Perhaps one way of looking at it is that the Fed controls interest rates, but makes decisions about them only after considering what is happening in the economy. Sometimes it can only react to events. Indeed, it is not clear that the Fed ever chooses or should choose the rates it would want in an ideal world. On the other hand, the Fed has been able to keep yields from rising too high on some important kinds of mortgage-related securities, etc., which is something that it deliberately sought to do. As you point out, one factor affecting Fed policy decisions is the expected demand for credit, but in the case of Treasury securities, of course, the issuer of the liability is the federal government, and it is clear that this entity’s issuance (“demand” for finance) has been very strong, due to the high deficits of recent years. So low yields are not likely the result of weak demand for finance, except by issuers of securities that are fairly close substitutes for virtually default-risk-free government debt. I think we are likely to agree on much of this. Thanks.
Keynes’s multiplier is a mathematical identity whereby a consumption function series equals the reciprocal of the savings function, and is completely useless, in spite of the intellectual confusion it usually causes.
I think it is more than that, given a few very simple and intuitive behavioral assumptions, such as a fairly stable savings propensity or set of savings propensities for each of several types of households. This assumption may be a reasonably accurate approximation of reality in the near future for many purposes. For example, if such assumptions hold (though we may not even have a very reliable estimate of the parameter values), then we have at least a rough guide to the effects of fiscal policy changes, and a rudimentary explanation of how such changes affect aggregate output. But there is certainly more to it, and there is no guarantee that economists can ever come up with a complete model. I hope this helps you understand my views on this issue.