Thursday, March 4, 2010

Raise inflation so as to reduce real interest rates? Bonkers!

Greg Manikiw (G.W.Bush’s senior economic advisor) and the IMF have unfortunately decided in favour of targeting higher inflation so as to bring about the option of lower real interest rates. At least that’s the case according to “Beat the Press".

The first problem here is that given negative real interest rate people or firms could, at least in principle, borrow money so as to make investments which make a negative return on capital. I.e. such investments would actually DESTROY REAL WEALTH. Mad or what?

Second, the purpose of negative real interest rates is to encourage borrowing and spending, and this would doubtless work, i.e. raise aggregate demand. But demand can perfectly well be raised at zero interest rates by the means long advocated by modern monetary theorists. This is, to put it bluntly, a helicopter drop. Or to put it in more sophisticated and realistic terminology create more monetary base (and, incidentally, channel it into the pockets of MAIN STREET AND NOT WALL STREET.) That’s what Warren Mosler’s payroll tax holiday would do.

Afterthought. An hour after posting the above I noticed an article in the WSJ expressing similar sentiments. It’s by the president of the Deutsche Bundesbank and chairman of the governing board of the Swiss National Bank.

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