Krugman’s blog, 10/2/15

There were two posts yesterday.  The first was “Why Bankers Want Rate Hikes:”

I’ve been arguing that a major source of the urge to hike interest rates despite low inflation is the self-interest of bankers, whose profits suffer in a low-rate environment. Right on cue, the BIS has a new paper documenting that relationship. The key argument:

The “retail deposits endowment effect” derives from the fact that bank deposits are typically priced as a markdown on market rates, typically reflecting some form of oligopolistic power and transaction services. If the markdown becomes smaller as interest rates decline, then monetary policy tightening will increase net interest income. The endowment effect was a big source of profits at high inflation rates and when competition within the banking sector and between banks and non-banks was very limited, such as in many countries in the late 1970s. It has again become quite prominent, but operating in reverse, post-crisis, as interest rates have become extraordinarily low: as the deposit rate cannot fall below zero, at least to any significant extent, the markdown is compressed when the policy rate is reduced to very low levels.

This is pretty much what I said in the linked piece. The chart shows the paper’s estimate of the effect of higher short-term rates on bank profits (the partial derivative); it’s strongly positive at low rates.

So it really is in bankers’ interest to demand monetary tightening, even when it’s inappropriate given the state of the economy.

The second post yesterday was “The Investment Accelerator and the Woes of the World:”

Jason Furman of the Council of Economic Advisers gave anilluminating talk on the sources of weak business investment, largely aimed at refuting the “Ma! He’s looking at me funny!” school, which attributes US economic weakness to the way the Obama administration has created uncertainty, or hurt businessmen’s feelings, or something. As Furman shows, it’s a global slowdown, very much consistent with the “accelerator” model in which the level of investment demand depends on the rate of growth of overall demand.

It seems worth pointing out, or actually reiterating, several implications of this analysis that go beyond Obama-bashing and its discontents.

First, if weak demand leads to lower investment, which it does, and if fiscal austerity is contractionary, which it is, then in a depressed economy deficit spending doesn’t crowd investment out — it crowds investment in. Or to be more explicit, austerity policies don’t release resources for private investment — they lead to lower private investment, and reduce future capacity in addition to causing present pain. Conversely, stimulus in times of depression supports, not hinders, long-run growth.

Second, secular stagnation — persistent difficulties in achieving full employment — is a real concern if potential growth is slowing due to a combination of demography and weak technological progress, which seems to be happening. Lower growth means lower investment demand, so getting the private sector to spend enough gets harder.

Finally, an extreme case of this arises in China, where the exhaustion of the reserve of underemployed peasants plus, perhaps, a slowdown in the rate of technological catchup means that the very high investment rates of the past can’t be sustained. Look out below.

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