Keynes predicted the
euthanasia of the creditor or rentier of the capital because he thought that
land and labour are scarce, but capital has no reason to be scarce, because the
central-bank can print money to stoke demand/supply to achieve full-employment.
In the developed-world the central-banks have pumped so much money in the system
that has made money so cheap that pushed interest-rate rock-bottom (Japan, US,
Europe). In these countries, capital is cheap and not scare, at all; interest
rates are at zero-lower-bound. These economies are very close to that (Keynes’
concept of) euthanasia, when interest rates are almost zero. If we take Japan
as an example which is reeling under recession for past two decades and
interest-rate near zero, euthanasia of the creditor seems very plausible. In
all the three economies interest-rate is near zero and they are also probably
in the famous Keynesian liquidity trap in which people accumulate reserves,
when nominal interest-rate is zero and cannot fall further and in the
expectation of lower prices forth they delay purchases. Prices reflect scarcity
and higher-prices reflect higher scarcity, even prices of labour
(wages) and capital (interest-rate). During downturns both are not scarce as
there is a cut down on investment and interest-rate (or increase in
money-supply) and employment and wages (or increase in unemployment and
labour-force). In an attempt to increase demand and growth, these banks failed
to understand the importance of savings which is also a function of real
interest-rate (nominal interest rate minus inflation). It has also led to capital-fight.
Moreover, in another attempt to make economy competitive we have also cut-down
on real-wages (nominal wages minus inflation). The continuous increase in money
supply and inflation has kept real-interest-rate-and-wages and demand low.
Moreover, slowing population growth rate has also affected demand negatively.
The central-banks are trying to push the economy through money-supply which is
supposed to increase spending and inflation, but this is even going to hurt
demand by lowering real-interest-rate-and-wages and might not work in the
liquidity-trap. Savings also do have a positive effect on demand through lower
interest rate and higher investment. Moreover, inflation will also lower
real-wages. These banks policies might have a negative effect on demand by
increasing inflation. The Fed is trying to push prices up which is opposite of
the argument that increase in real-wages will also increase demand, the
Pigou-Effect. The effect is also helpful in the liquidity-trap by increasing
real wages and demand. Growth-rate of the economy will increase. The Fed should
try to release the repressed demand by increasing real-wages and stop inflation
targeting and let the prices fall to increase demand. Lower interest rate, as
they are, will help increasing investment. The interest rate in these countries
might remain very low, probably zero, for an indefinite period of time (may be
forever) because in these capital rich countries, capital is not scarce
anymore... Japan is a good example...
Interest-rate depends
upon the money-supply, the price level and expectation of changes in it,
because of the price-stability objective of the monetary-policy or the
central-banks. They manage money-supply to adjust interest-rate and
demand/supply which jointly determines the price-level or inflation. But,
interest-rate in turn is also determined by inflation and inflationary
expectations, both short-run and long-run. Higher inflation and inflationary
expectations also make the central-banks fine-tune money-supply and
interest-rate. Normally central-banks job is to ensure price-stability, but
when growth-rate is tumbling it might set higher-inflation-targets, because it
is a sign of higher demand/supply and economic-activity. Generally, booms and
high growth-rates coincide with higher prices and interest-rate. Nonetheless,
busts and slow-downs in the economic-activity and growth-rate calls for lower
interest-rates, but to cut interest-rates during down-turn it is important to
tighten during higher inflation otherwise it would feed bubbles by increasing
the gap between nominal and real prices of assets because of inflation. The
fear that lose money-supply and interest-rate might create asset-price-bubbles
in the US is baseless since inflation is too low. Moreover, the fear of risky
investment because of too low rates is again overdone since banks lend only
after assuring feasibility of the project. Nevertheless, low interest-rate on
retirement-funds also depends on inflation and inflationary expectation, and,
low interest-rate would also mean that inflation in future could remain low
which means higher real-interest rates, and the argument that pension funds
might lose because of low rates may also be overblown because it would also
signal that inflation could remain low in the future so that less savings would
be needed. With oil from the Shale-revolution, which had put
the expansion of the US economy in shambles many times before. Lower oil-price
expectations in the economy has kept inflationary expectations and interest
rate low, which is likely to stay because the US is now a big oil producing
country. Most of the prior recessions in the US economy were associated with
oil-price booms and inflation. Lower oil-prices are a major contributor to low
inflation and inflationary expectations after Shale. Higher oil-prices in the
future would also make high-cost shale-exploration more viable, and, thereby
more production and supply leading to further low oil prices, inflation
expectations and interest-rate.
It is worth a thought
that economic-models assume zero inflation in the long-run. Inflation is a
short-run deviation from the equilibrium price-level. Economists think of the
long-run as self-correcting. But when deciding long-run rates expected
inflation plays an important role because the economy first consumes and then
saves for the future; if they expect higher inflation based on the current
situation they would also save more for the future too and more savings result
in lower spending means lower demand and prices. Interest rate would go down.
On the contrary, if they expect deflation based on the current condition they
would save less-spend more which might increase demand and prices and interest
rate. People expect higher interest rate if there is inflation because the
monetary-policy would work to control inflation. Generally, prices and interest
rate move in the same direction. Expected inflation would increase the long-run
rates, higher than the short-run rates. The long-run rates are higher than the
short –run rates which shows that depending on the economic –policy people
expect inflation in the long-run which is opposite of what the economic models
assume that inflation in the long-run would be lower or zero. Keynes long ago
accepted that labour and other factors of production might not be abundant but
capital has no reason to be scarce since the central bank can print money to
finance the economy. Gold-Standard off-load was a big move in that direction
which was later used to print notes, buy foreign exchange and devalue to gain
exports. Keynes foresees capital as not scarce in the long-run. Our zero
interest-rate regimes in much of the developed world do support Keynes view
that capital is not necessarily scarce. Higher long-run interest rate is
against Keynes argument of lower interest rate.
