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Interest Rates Re-Examined - June 12, 2019

“They’ve Got It Backwards”

 Last week, we looked at Ken Rogoff’s recent speech detailing why negative interest rates are likely and how to implement them. This week, people who disagree with some of the assumptions underlying central bank policy caught our attention.

First on our list is Warren Mosler, who said that central banks have “got it backward” in a May interview with Bloomberg. Mosler, “one of the leading voices in the field of Modern Monetary Theory”, argued that “Higher rates are actually expansionary and reflationary, lower rates are actually contractionary and deflationary”. He supports this claim by pointing out that the government is a large net payer of interest and clarifies that rising rates are “like basic income for people who already have money”. Mosler further said that “it’s become more obvious that interest rate policy doesn’t work”, and pointed out that economists whose models are “broken” are “just leaving out this interest income channel”. He doesn’t disagree entirely with Rogoff’s assessment of Fiscal policy, saying “congress has always been driving”, likening the Fed to a toddler in the backseat with a toy steering wheel.

Our second contrarian is Jim Chanos. According to an article from Business Insider, the “famed short-seller” gave a speech at the Indian Harbor Yacht Club in Greenwich where he argued that “the Fed itself” is to blame for the current situation. Chanos explained that not only have low-interest rates enabled all kinds of “deflationary businesses to flourish”, but they have also gotten “in the way of the market’s ability to efficiently weed out non-performers”. Chanos also blamed Silicon Valley “Unicorns”, such as Airbnb and ridesharing companies, for bringing down prices, arguing “they’re deflating rents, they’re deflating driver salaries, they’re deflating all kinds of things”.

Last in our list of contrarians are Ben Hunt of Epsilon Theory and Robert Carnell of ING. Both Hunt and Carnell addressed counterintuitive behaviors exhibited by savers at low and negative rates. Carnell writes in his note on policies executed by the BoJ that “the power of low rates to boost economic activity seems to have diminished” and suggests one explanation for this is “that as rates approach zero, the IS (investment-savings) curve becomes non-linear”. The practical result of this relationship is that, after a certain point, as rates drop, rather than decreasing, savings increase:

“Indeed, as rates have been cut towards zero, savings haven’t always been reduced and substituted for spending. Instead, today’s 50-somethings will likely save even harder”.

Hunt is on a similar track in his article, “A Song of Ice and Fire”. Hunt makes a comparison to the nonlinear behavior of water at low temperatures to argue that, though central bankers “believe that lowering the price of money... would act on risk-taking in the same linear fashion”, “when the price of money gets really cold [sic] low, like close to zero degrees [sic] percent low, risk-taking behavior changes”. With markets currently pricing in three rate cuts by the end of the year, it appears that participants expect low-interest rates to continue.