43 Interest Rate
What debt does, no more and no less, is to establish a contractual agreement to tie an allocation of resources in the present to a mirroring reallocation of resources in the future.
If they cannot be paid, the one thing we know about debts is that they should be written off. [Tooze (2022) Chartbook #181: Finance and the polycrisis (6): Africa’s debt crisis](https://adamtooze.substack.com/p/finance-and-the-polycrisis-6-africas
43.1 Natural Rate of Interest
Roberts
Indeed, ‘managing’ an anarchic capitalist economy is not easy – indeed impossible. Even worse, the navigation guide that Powell and mainstream economics are trying to use is the so-called ‘neutral policy rate’ that supposedly tells economists when demand and supply; or more accurately, aggregate savings and investment, are in balance.But this r*, as it named, is a nonsense concept that comes from the neoclassical equilibrium economics of Kurt Wicksell.. Many studies have shown up the myth of this theory. It’s less an astronomic navigation tool and more the astrology of the zodiac. Nevertheless, Powell referred to this ‘natural rate of interest’ theory as his policy foundation, but then dissed it by saying “we cannot identify with certainty the neutral rate of interest, and that assessment is further complicated by uncertainty about the duration of the lags with which monetary tightening affects economic activity and especially inflation.” Yes, indeed.
Roberts (2023) Navigating by the stars under cloudy skies – and holed below the water line
43.1.1 From R* to r
Roberts
The Fed has been following a monetary policy theory that there is some ‘equilibrium’ rate of interest that can be identified that would be appropriate for an economy to be back at trend growth and full employment without serious inflation. The Fed calls this (imaginary) rate, R. This idea is based on the theory of the neo-classical economist Kurt Wicksell. The trouble is that it is nonsense – there is no equilibrium rate. Even worse, the Fed’s economists have no idea what it should be anyway. In their latest projection, they reckon R is anywhere between 1% and 5% for two years ahead, with a best guess at about 2%. The current Fed rate is 0.5%.
R* is not really anywhere near as high as the Fed economists think. The major economies are in a state of ‘secular stagnation’ caused by ageing, slowing productivity growth, falling prices of investment goods, reductions in public investment, rising inequality, the “global savings glut” and shifting preferences for less risky assets. If we recognise that R* is really low, then we can adopt the policy of handing out cash to companies and individuals directly and combine that with more public spending (with larger government budget deficits) on investment projects. These answers are really an admission of the failure of monetarism and monetary policy.
The capitalist economy does not respond to injections of money (or, for that matter, injections of government spending) but to the profitability of investment. The rate of profit on capital invested is the best indicator for investment and growth, not the rate of interest on borrowing. It is r, not R*, that matters.
43.2 Unpayable debt in a Stationary Economy
Hartley Abstract
Under what circumstances are interest-bearing loans compatible with an economy without much growth? The question is becoming increasingly important given a tendency towards declining growth in industrialised economies and increasing evidence that continued growth is incompatible with environmental sustainability. Previous theoretical work suggests that when interest-bearing loans compound, this results in exponentially growing debts that are impossible to repay in the absence of economic growth. We here examine ten historical cases to assess support for this finding. We find that interest-bearing loans have typically resulted in unpayable debts in these non- and slow-growing economies. We further identify four broad category of measures to prevent or alleviate the problem of unpayable debts, and show how they have been employed in the past. Our Appendix compiles sources of debt regulation from across the world over five millennia.
Hartley Memo
Compound interest debt-based money is incompatible with a stationary economy but interest bearing debt-based money does not necessarily imply compound interest.
Positive interest rates do not systematically lead to exponentially growing deposits, because taxation and consumption out of wealth and income can dampen the positive feedback loop of compound interest.
Our starting point for this paper, then, is the longstanding body of literature which suggests that when interest compounds it can result in exponentially growing debts that are unpayable in the absence of economic growth. This body of theory has been developed to analyse modern economies, with the particular aim of better understanding what may happen if today’s economies stop growing.
Rome, for example, had significant levels of financial intermediation and credit creation, with one recent comparative analysis concluding “that financial institutions in the early Roman Empire were better than those of eighteenth- century France and Holland. They were similar to those in eighteenth-century London and probably better than those available elsewhere in England”
What particularly motivates us here is a desire to un derstand the consequences of positive interest in the absence of growth, and also to shed light on how these societies tried to mitigate the potential negative effects of interest-bearing loans.
The charging of interest in the absence of substantial economic growth was accompanied by notable levels of unpayable debt in seven out of our ten cases.
In these seven cases, there is evidence that in different periods this resulted in debtor dispossession and indenture, and at least some degree of social upheaval or revolt.
The more extended lending is, the more individual problems of indebtedness are likely to translate into a bigger social problem.
One might also argue that if lending markets worked efficiently, real interest rates in modern economies should converge towards the rate of real economic activity, which would suggest that real interest rates in a non-growing economy should tend towards zero.
Current theories that suggest interest-bearing loans may become problematic in the absence of substantial growth have significant empirical support when tested against historical cases.
Hartley and Kallis (2021) Interest-bearing loans and unpayable debts in slow-growing economies: Insights from ten historical cases (pdf) (SI pdf)