Interest Rate Changes are double-edged.
Manipulation of Microeconomic Rates Betrays a Lack of Adequate Understanding of the Process.
In a creative-destructive economy in a finite world, particular expansionary capital spending surges, then slows, and eventually exhausts its opportunities. Therefore, the associated non-consumption incomes – i.e. savings or pure surplus incomes – that are devoted to investment expenditures must surge, then slow, and eventually flatten out. In a finite world the rates of saving and borrowing must change in conformity with the changing requirements and opportunities of the evolutionary process.
The reader has, no doubt, been deluged with news about the Central Bank’s manipulation of interest rates to manage the economy. In the following excerpt, the reader should understand and engrave in his mind the phrase “factors that are prior to changing [1] interest rates and more effective.” To wit:
The purpose of this section is to inquire into the manner in which the rate of saving w is adjusted to the phases of the pure cycle of the productive process. Traditional theory looked to shifting [2] interest rates to provide suitable adjustment. In the main we shall be concerned with factors that are prior to changing interest rates and more effective. [CWL 15, 133]
We wish to learn the elements of effective management of the economy. Thus, if manipulation of interest rates may be double-edged and possibly counter-productive, we must get a grasp of “factors that are prior to changing [3] interest rates and more effective.” To that end, we divide incomes into many strata or groups of people having certain levels of income. We symbolize basic (consumption) income as follows:
I’ = Σ winiyi [CWL 15, 134]
where i represents any group, wrepresents the fraction of total income directed to basic income, nrepresents the number of members of the group, and yrepresents the aggregate (basic plus surplus) income of the average member per interval.
And we symbolize the change in basic income as + dwidni
dI’ = Σ(widni + nidwi + dwidni)yi[CWL 15, 134]
Therefore,
Evidently, then, “suitable migrations” are a means of providing adjustments in the community’s rate of saving. To increase the rate of saving (for expansionary investment), increase the income of the rich. … to decrease the rate of saving (to expand consumption and fully utilize new capital), increase the income of the poor. … The foregoing is the fundamental mode of adjusting the rate of saving to the phases of the productive cycle. It reveals that the surplus expansion is anti-egalitarian, inasmuch as that expansion postulates that increments in income go to high incomes. But it also reveals the basic expansion to be egalitarian, for that expansion postulates that increments go to low incomes [CWL 15, 135-37]
… (And,) unless the quantity of money in circulation expands as rapidly as prices rise and, as well, as rapidly as the productive expansion of quantities requires, there will result a contraction of the process: then, instead of adjusting the rate of saving to the requirements of the productive cycle, the productive cycle is arrested to find adjustment to the rate of saving. [CWL 15, 135-37]
To increase pure surplus income for investment, let people migrate upward into and among the higher-income groups; i.e. let more people enter into and rise within the series of higher-income strata. To increase consumption to effect a basic expansion and fully utilize new capital, let people migrate upward within the lower-income groups; i.e. let more people enter into and rise within the lower-income strata. These migrations are “prior to changing[4]interest rates and more effective.”
Traditional theory looked to shifting interest rates (to manage the economy). The difficulty with this theory is that it overlooks the order of magnitude of the fundamental problem and lumps together a number of quite different things. [CWL 15, 141-144]
The phrase “lumps together a number of quite different things” refers to the following failures:
- the failure of economists to identify credit money as the normal source of expansionary investment funds,
- the failure to distinguish the different effects of higher or lower rates of interest on projects of different durations or frequencies,
- the failure to understand the nature, purpose, and effect of, and to distinguish between, i) credit for production vs. ii) credit for purchasing more than has been earned vs. iii) credit for gambling.
Again, more fully,
Traditional theory looked to shifting interest rates (to manage the economy). The difficulty with this theory is that it overlooks a) the order of magnitude of the fundamental problem and b) lumps together a number of quite different things … (as for the magnitude of the problem) it would take enormous interest rates backed by all propaganda techniques at our disposal to effect the negative values of dwi (i.e. reduction of consumption percents) that are required interval after interval as the surplus expansion proceeds; what is needed is something in the order of ‘incentives to save’ that is as rapid and as effective as the reduction of purchasing power by rising prices. … [CWL 15, 141-144]
(as for lumping together a number of quite different things) the ineptitude of the procedure arises not only from its inadequacy to effect a redistribution of income of the magnitude required but also from its effects upon the demands for money. Four types of such demand may be distinguished….the effect of raising interest rates to encourage savings is not to keep the rate of saving and the productive process in harmony as the expansion continues but simply to end the expansion by eliminating its long-term elements. [CWL 15, 141-144]
Rather than using procedures that are roundabout and inept, the monetary, fiscal, and entrepreneurial authorities should employ “factors that are prior to changing [5] interest rates and more effective.”
A general operation upon the supply of money seems to be a rather roundabout and inept procedure to correct an error in distribution. [CWL15, 143]
(In a context of an assumed constant money-supply) rates of interest, when increasing, encourage saving (but discourage borrowing). This double edge is not the per se means of effecting the enormous shift in saving to bring about the transition from a slump or a basic expansion to a surplus expansion. (Assuming a constant money supply,) what is needed is a contraction of purchasing power that will direct spending from the basic market of the poor to the surplus market of the rich. The surplus phase is anti-egalitarian…….
Similarly, a lowering of interest rates may (discourage saving and increase consumption, and it may) encourage the expansion of basic industry; but it also will encourage the expansion of well-intentioned but not well-thought-out innovations, the number of bankruptcies, etc. What is needed (rather than lower interest rates) is the egalitarian shift in incomes, that will compensate for the previous and shorter anti-egalitarian shift, and will produce the things that people really need and can learn to purchase without the help of self-seeking advertisers. [CWL 15, 141 ftnt 198]
Manipulation of interest rates can be counterproductive.
When the rate of savings is insufficient, increasing interest rates effect an adjustment. This adjustment is not an adjustment of the rate of saving to the productive process but of the productive process to the rate of saving … it does not deserve the name adjustment. It is delayed because the influence of increasing interest rates on short-term enterprise is small. It does not deserve the name ‘adjustment’ because its effect is not to keep the rate of saving and the productive process in harmony as the expansion continues but simply to end the expansion by eliminating its long-term elements.[CWL 15, 144]
It is discouraging to hear winners of the Prize in Economic Sciences[6]advocate the manipulation of interest rates as though a change in the interest rate were single-edged and cutting in only one direction. Their arguments are self-contradictory, and full of oversights and omissions.
Interest rates pertain to both lenders and borrowers. If the Central Bank’s reducing of interest rates amounts to having one foot on the accelerator (reducing the cost of investment) and the other foot on the brake (discouraging the saving on which investment depends), it should understand and acknowledge that condition and compare the net effect of the separate, competing, contrary effects.
The excerpts already provided are worth rereading if one wishes to gain a solid understanding of credit phenomena. The reader would benefit from dwelling on, pondering, and understanding the meaning of the following passages:
Evidently, then, suitable migrations are a means of providing adjustments in the community’s rate of saving. To increase the rate of saving, increase the income of the rich. … to decrease the rate of saving, increase the income of the poor. [CWL 15, 135-37]
This double edge is not the per se means of effecting the enormous shift in saving to bring about the transition from a slump or a basic expansion to a surplus expansion. [CWL 141 ftnt 198]
instead of adjusting the rate of saving to the requirements of the productive cycle, the productive cycle is arrested to find adjustment to the rate of saving. [CWL 15, 135-37]
Thus the root of the failure of the mechanism is the failure to obtain the (normative) shift in the distribution of income. … What is needed (in the basic expansion) is the egalitarian shift in incomes, that will compensate for the previous and shorter anti-egalitarian shift (in the surplus expansion). [CWL 15, 138 and 141]
This adjustment is not an adjustment of the rate of saving to the productive process but of the productive process to the rate of saving … It does not deserve the name ‘adjustment’ because its effect is a) not to keep the rate of saving and the productive process in harmony as the expansion continues, but b) simply to end the expansion by eliminating its long-term elements. [CWL 15, 144]
[6] often mistakenly called The Nobel Prize in Economic Science.