Paul Krugman gave a paper at a recent conference at the University of Cambridge to honor the 75th anniversary of the publication of John Maynard Keynes’ great work, The General Theory of Employment, Interest and Money. The paper is very readable. There are snide remarks about economists who ignore the hard-earned wisdom of the past, and an explanation of the failure of our political system to come to grips with the Little Depression, in Brad DeLong’s accurate phrase.
There is also a somewhat wonky explanation in Keynseian terms why issuance of more debt does not drive up interest rates. Too briefly, Keynes says that levels of the supply and demand for money in the form of savings and investment can only be determined at given levels of income. This is intuitively appealing, because as income rises, people save and invest more, and if incomes are lower, they save and invest less. Of course, there are many other factors for specific people, and therefore, in the aggregate the curves are different at different times and situations.
… ]W]hat the supply and demand for funds really give us is a schedule telling us what the level of income will be for a given rate of interest. That is, it gives us the IS [investment/savings] curve of Figure 5; this tells us where the central bank must set the interest rate so as to achieve a given level of output and employment. Of course, as the figure indicates, it’s possible that the interest rate required to achieve full employment is negative, in which case monetary policy is up against the zero lower bound, that is, we’re in a liquidity trap.
Krugman says that in a liquidity trap, government borrowing won’t drive up interest rates. It will just sop up some of the excess savings, satisfying people’s need for safety and liquidity, a necessary and important step to providing stability to the economy. That good thing requires government action: therefore in our crazy political environment, it is evil.
Take another look at Figure 5: the problem is that in order to reach full employment, we would need a negative interest rate. Since we seem to be there, and since the models allow it, maybe we should take another look at that seeming impossibility.
A positive interest rate means that people get their principal back and some extra money on top, the interest. We can interpret negative interest rates as lenders not getting their principal back in full. With inflation running higher than interest rates, people with money in the bank are gradually losing the purchasing power of their money. We can interpret that as negative interest.
Now think about credit card debt. All over the country, people owe a lot of money on credit cards, and a lot of those people aren’t going to repay that debt. That too is a form of negative interest. On those loans, banks aren’t getting 24%; they are getting a negative return. It may be that taken as a whole, the business is still profitable, but on the specific credit card loans, they are getting a negative interest rate.
In the same way, a lot of people can’t pay their mortgage loans. Those lenders are also getting a negative return on their money. That seems fair, doesn’t it? They put their money at risk in foolish ways, and they should pay the price.
Instead of allowing this natural business system to work itself out, our frightened politicians ran to the rescue, unwilling to allow rich lenders to lose money. The Obama Administration has decided that it won’t accept the negative interest rate necessary to produce full employment, and just as the curve predicts, we don’t have full employment.
That just makes the problem worse: people’s income drops, or they fear that it will, and their desire to save to protect themselves increases. As consumption falls, employment continues to decrease, in a downward spiral. This government isn’t going to deal with the consequences of its decision to protect the ancient claims of lenders, and there isn’t any way to get out of this problem.
The claims of lenders are claims on future income of borrowers. Every branch of government cooperated to force borrowers to devote their income to the payment of ancient claims. Congress changed the Bankruptcy Code to force people to devote their future income to paying off lenders. Programs ostensibly designed to protect homeowners were so bad they look like intentional efforts to destroy the beneficiaries they pretend to protect. The stimulus was poorly conceived and too small. Courts allowed fraudulent foreclosures, and refused to intervene to protect homeowners and borrowers. The Obama Administration refused to do the one thing that would work, a direct jobs program. The only claims that matter are the claims of the fraudsters that got us into this situation.
Massive unemployment is the logical outcome of protecting banksters.