Some economists have been arguing that the “equilibrium
real interest rate” (that is the “natural interest rate” or the “originary
interest rate”) has become negative, as a “secular stagnation” has
allegedly caused a “savings glut.”
The idea is that savings exceed investment, and that a
negative real interest rate is required for bringing savings in line with
investment. From the viewpoint of the Austrian school, the notion of a
“negative equilibrium real interest rate” doesn’t make sense at all.
To show this, let us develop the case step by step. To
start with, one should make a distinction between two types of interest
rates: There is the market interest rate, and there is the originary
interest rate.
The market interest rate is the outcome of the supply of
and demand for savings in the market place. It can be observed, for instance,
in the deposit, bond, or loan market for different maturities and credit
qualities.
The originary interest rate is a category of human
action, saying that acting man values goods available at present more
highly than goods available in the future. In other words: Future goods
trade at a price discount relative to present goods. For instance, 1 US$
available today is preferred over 1 US$ available in one year’s time.
If 1 US$ to be received in one year’s time is valued at,
say, 0.909 US$, the originary rate of interest is 10 percent. (1 US$ divided
by 0.909 minus 1 gives you 0.10, or 10 percent, for that matter.) 10 percent
is here the originary interest rate (disregarding any other premia).
The “Originary Interest Rate” Reflects a Value
Differential
The originary interest rate is expressive of a value
differential, which results from so-called time-preference. The
term time-preference denotes that acting man prefers an earlier satisfaction
of wants over a later satisfaction of wants.
Time-preference is always and everywhere positive, and so
is the originary interest rate. This is, first and foremost, what common
sense would tell us.
If the originary interest rate was near-zero, it means
that you prefer two apples available in, say, 1,000 years over one apple
available today. A truly zero originary interest rate implies that
the actor's planning horizon or “period of provision” is infinitely
long, which is another way of saying that he would never act at all
but would continually push the attainment of his goals into the future.
The notion that time-preference and the originary
interest rate could be zero, does not only sound absurd, it is also a logical
impossibility: Positive time-preference and a positive originary interest
rate are logically implied in the irrefutably true “axiom of human action.”
Human action is purposive behavior, implying the use of
means to achieve ends. Action requires time (it is impossible to think
otherwise). Thus, time is an indispensable and scarce means for achieving
ends. As such, it must be economized, which necessarily implies that an
earlier satisfaction of wants is preferred over a later satisfaction of
wants.
For (praxeo-)logical reasons, therefore, time preference
and the originary interest rate cannot fall to zero, let alone become
negative. The implications of a negative originary interest rate cannot even
be conceived by the human mind: A zero originary interest rate already
implies no action ever into eternity.
Unconvincing Arguments
However, some argue that due to growing uncertainties
related to longer life expectancy, people might increasingly prefer future
consumption over present consumption; and that this could push time
preference and the originary interest rate into negative territory.
No doubt, peoples’ time preference may decline over time,
implying that savings out of current income increases while consumption
declines. While time preference and thus the originary interest rate can
fall, for logical reasons they cannot hit zero, though, let alone become
negative.
Another argument refers to the issue of “saturation” and
runs as follows: Let’s assume you have two apples, and you eat one of them.
Your hunger is now saturated, so that you prefer eating the remaining apple
tomorrow over eating it today. Doesn’t this prove that people may value
future goods more highly than present goods, that time preference and the
originary interest rate may be negative?
No it doesn’t. Non-consumption of the second apple today
can easily be explained by the fact that the marginal utility of eating the
apple now is lower than eating it tomorrow or the next day, even when the
future marginal utility is discounted by a positive originary interest rate.
That said, the example above is misconstrued. It
does not illustrate the relevant case, namely the case in which
acting man considers alternative uses of one and the same good — and
thus doesn’t prove at all that time preference and thus the originary
interest rate can be negative.
The End of the Market Economy
What is the relationship between the market interest rate
and the originary interest rate? In the loan market, for instance, the interest
rate on loans is adjusted to the rate or originary interest. If, for
instance, the originary rate of interest is 2 percent and the credit and
inflation premia are 1 percent, respectively, the market interest rate would
be 4 percent.
Market interest rates
may become negative in real terms. In a “hampered market,” for instance, the
central bank can push the real market interest rate into negative territory.
However, this does not, and cannot, represent an equilibrium, as time
preference and thus the originary interest rate cannot become negative.
Should a central bank really succeed in making all
market interest rates negative in real terms, savings and investment would
come to a shrieking halt: as time preference and the originary interest rate
are always positive, “capitalistic saving” — the accumulation of goods
designed for improving the production process — would come to an end. Capital
consumption would ensue, throwing mankind back into poverty. It would be the
end of the market economy.
It might be interesting to note in this context that, for
instance, the German national socialists had called for the abolition, the
prohibition of the interest rate. Now you know why: Without a positive
(originary) interest rate, the market economy will cease to function.
The True Purpose of Negative-Interest-Rate Policy
For some reason, those who argue that the originary
interest rate has become negative seem to overlook that the originary
interest rate is a phenomena which is not confined to credit markets. It
pervades all markets in which present goods are exchanged for future goods.
For instance, the originary interest rate prevails at
each stage of the economy’s time-consuming roundabout production. The
originary interest rate also exists in the stock market, where investors
exchange present money against a claim on future money (that is a firm’s
dividend payment).
If they wanted to be consistent, the believers in a
negative originary interest rate would have to call for a policy that does
not only make interest rates negative in real terms in the credit market, but
also in the markets for, say, stocks and housing.
However, a policy that advocates destroying firms’ values
and peoples’ housing wealth wouldn’t be taken too kindly by the public at
large; and those economists recommending it couldn’t expect being cheered.
The consequence of a policy of a negative real market
interest rate should have become obvious by now: It is an actually perfidious
policy for debasing the real value of outstanding debt; and it is a recipe
for wreaking havoc on the economy.
Article originally published at www.mises.org
Image source: iStockphoto
