Thursday, October 30, 2008

A discussion of zero percent interest rates

And no where does the word liquidity trap come into it. Fascinating.

Edmund Andrews of the New York Times

A growing number of analysts now predict that the economy is so weak that the Fed will have to reduce its official target to zero if it wants to jumpstart the stalled economy.

Japan’s central bank reduced its benchmark interest rate to zero for five years, from 2001 to 2006. It did so mainly to combat a particularly persistent case of deflation, a broad-based decline in consumer prices, and to revive economic growth.

Some analysts see signs that the United States faces a similar threat. Like Japan’s, American banks have become so decimated by losses in real estate that they are either unable or unwilling to resume normal lending. And as prices for oil and many other commodities have crashed during the past two weeks, some analysts now warn that deflation might be a threat here as well.

With the Fed funds rate already down to 1 percent, and below one percent on many days, the central bank is fast approaching what economists call the “zero bound.”


The real question for policy makers is what to do if they reach a zero rate and still want to rev up the economy.
Which is the exact description of a liquidity trap, Mr. Edmund Andrews:

Liquidity trap
In monetary economics, a liquidity trap occurs when the economy is stagnant, the nominal interest rate is close or equal to zero, and the monetary authority is unable to stimulate the economy with traditional monetary policy tools. In this kind of situation, people do not expect high returns on physical or financial investments, so they keep assets in short-term cash bank accounts or hoards rather than making long-term investments.
For those who are able to read economic papers, Paul Krugman's papers on Japan and liquidity traps.


Mahakal / מהכאל said...

It can even go below zero. That's when we're paying people to take our money!

Distributorcap said...

i am with mahakal --- they will owe us money.....

the greed of the wall st execs and republican party ---- and we just it continue

ellroon said...

Wow. Just think. Bankers pleading with you to buy a car, a house, anything! Just go into debt just a bit!!

I think I'll just sit on my money for a while more...

ellroon said...

I hear you, dcap. They owe us big time.

Makes me think of the (almost) satirical sign appearing after the first of the crashes out on the sidewalks of Wall Street: Jump, you fuckers!

The parties that continued AFTER the bailout, where AIG bigwigs went partridge hunting in Britain shows that the sense of entitlement hasn't yet been punctured by reality.

That's OUR money they're fucking around with. They owe us big time.

Mahakal / מהכאל said...

The problem with sitting on your money when interest goes negative is that the money will devalue while you hold it. That's why they will want you to give you a premium to take it off their hands. If you don't borrow it and buy something with it now, you won't be able to buy as much (or anything at all, if the currency collapses) later.

ellroon said...

I assume that's why people are being encouraged to buy gold (which has also fallen), euros (taking along with us), real estate (foreclosures!), and diamonds (manipulated market)?

I can see why they want me to spend now, but if I hold on to it for a long time, won't it slowly go back up?

Or maybe the best thing to buy is a cabin by a stream, survivalist gear, and a vegetable garden? Or maybe a passport?

It's going to get way worse before it gets better....

Adam Smith said...

Prepare for the New World Economic Order

Interest Rates [Credit] are the Cause and Consequence of the Explosion of Income/Wealth Disparities and, Hence, of the Inherent Instability of this Economy:

The Ominous Keynes' Liquidity Trap.
Origin of Economic Chaos.

Everyone Need an Economy, Don't They?

There Is One Solution That Works:

A Credit Free, Free Market Economy:

The New World Economic Order.

The Only Goal of 1776 - Annuit Cœptis is to Implement It.

They Can Transfer Their Assets & Forget Their Liabilities.

Anyone Can Join But Still Needs to Ask for It.

The Purpose Is to Provide Both a New Deal and a New Game.

It is NOT to Fix This Economy Which is Already Beyond Repair.

The Intention Is to Create a New Economy
With the Assets of the Old One Without its Liabilities.

Why Not Insure Against the Worst Case Scenario?

ellroon said...

Whoa, thanks for the info and the link, Adam Smith! I am a complete novice in economics, so it's nice to be exposed to many different theories.

Adam Smith said...


We are glad you welcome our comment.

What we want to stress is the fact that Credit discriminates against te poor.

Hence any credit based economy would it be a "free market" one does not give an equal opportunity for all.

But apart those moral considerations we found out that a Credit based system does necessarily fall in a Liquidity Trap:

Because it makes rich relatively richer and the poor relatively poorer.

The consequence of which is that less and less of the money is used for consumption (most of the money of the poor goes to consumption) and more and more money goes to investments (most of the money of the rich is used for savings and investments) so more and more is saved with less and less revenues and profit.

This is the return on investments. As it goes down so does long-term interest rates (the solution of the Greenspan Conundrum).

Long-term interest rates have been going down steadily since 1981. So it shouldn't have been a surprise to most economist.

When long-term interest rates are so low as not to reward the risk, savers stay on the sideline and prefer Liquidities rather than long-term investments.

It is the Ominous Keynes Liquidity Trap.

A mild version of it has plagued Japan since 1993 and has caused Japan lost decade which is 15 years old now.

We are very displeased that no one has ever questioned the role of interest rates in the equity and stability of economy.

In particular those who pretend to defend the interest of the disadvantaged and those who are in charge of the stability of the system.

We consider that only the defence of vested interests can explain such a dramatic failure.

So it is not the greed of a few but the build up of the system which is responsible for those dramatic events.

No one who have vested interest in that economy is fit to provide an answer to our problem.

Since 1994 have we tried to find a appropriate solution and the way to achieve it.

Alas, we have come to the conclusion that only the complete demise of that system will prevent vested interests to let our system develop.

We have tried to set up a system so light that it could be implemented a few days after the catastrophic event.

But the efficiency of any economy is a function of the numbers of his participants, regardless of their wealth.

We count on Bloggers, not on elected individuals, as having collectively no vested interest in that economy, to spread the word and hence minimise the hardship on the People.

As for the idea that people could use a 0% interest rate for a real economy we believe it to be not realist: why would people led their money with no return?

On the other hand they would gladly invest their cash in stocks and all the more so that the economy would be a stable one.

Yours, Sincerely,

Adam Smith

ellroon said...

A lot to get my head around, but thanks again for explaining!