[OPE-L:6117] Re: Re: possible ways out of the 'crisis'?

From: Patrick L. Mason (pmason@garnet.acns.fsu.edu)
Date: Wed Oct 31 2001 - 10:52:09 EST


Until 9-11 lower interest rates helped sustain a strong housing market. 
And, as you note, even for those households that do not purchase homes, 
lower interest rate will help lower monthly debt. Many individuals have a 
large amount of debt with variable interest rates. Households that are net 
borrowers receive an immediate improvement in their debt standing with 
lower interest rates because a) if monthly payments remain constant more of 
the payment is going to debt reduction and not interest, or b) lower 
interest rates may mean lower monthly payments. Reducing interest rates on 
automobiles from 7 - 11 percent to the currently fashionable 0 percent will 
certainly keep the automobile sector from slumping as much as it might have.

Few working class households receive much by way of interest income. In any 
case, today's interest income is largely the result of past bond 
investments when rates were higher. So, with declining interests those 
households who purchased bonds in the past - say anytime greater than 18 
months ago, are able to realize substantial capital gains.

Low interest rates are unequivocal benefit to the overwhelming majority of 
households. In part, the Fed initially raised interest rates to squeeze out 
stock market speculation, to bring price-earnings ratios back in line with 
historical averages. So, I don't think Greenspan et al. are particularly 
distressed about the current level of stock indices even if they are 
carefully watching the direction of movement.

If lowering interest rates is futile, do you prefer rising interest rates? 
Constant nominal rates with declining inflation - in which case we get 
higher real interest rates?

Nobody has a fail-safe plan for increasing aggregate demand. Greenspan's 
stated objective has been (I paraphrase) "the maximum level of growth 
consistent with price stability." In the past, the Fed seemed to have 
interpreted "price stability" to equal zero inflation. Today, the Fed seems 
to interpret "price stability" to equal a constant (predictable) but low 
level of inflation, say 2.5 - 3.5 percent. My guess: as long as AD is weak 
and there is no sign of inflation being a problem the Fed will cut interest 

Nobody seriously believes the madness of supply economics rhetoric. 
Greenspan is a conservative but he's not an idiot. In the long run, we are 
all "supply-siders," that is to say, the big issues in the long run are 
greater capacity, greater productivity, technological change, and altering 
the distribution of income. In the short run, capacity utilization is the 
issue that matters. Most of the Fed members are sufficiently pragmatic to 
know that they must lower interest rates to increase capacity utilization. 
There's no guarantee that lower rates will work but there is no empirical 
or theoretical reason to believe that lower rates will cause damage to the 

But, monetary policy alone is not sufficient. Keeping a severe recession 
away may require an enormous deficit. Reagan ran huge deficits in his 
version Keynesianism. To a certain degree, they worked. Family poverty 
rates, especially among African Americans, fell dramatically from 1983 
onward though they rose from 1971 to 1983. Measured from 1982, family 
income also increased dramatically though there was a reduction in 1991-92. 
Ironically, home ownership rates stagnated for whites and strongly declined 
among African Americans. Why? Extremely high real interest rates and 
crushing household debt burden.

peace, patrick l mason

>c) On whether cuts in interest rates can help the working class. Some
>workers may re-finance their homes. However, not many workers
>under the current [recessionary] conditions are going to purchase
>[new or used] homes. Indeed, I think that this will also be the case with
>all major consumer durables.  Perhaps some workers will take out bank
>loans to pay-off credit card debt (something to consider so long as there
>is a major difference between interest rates offered to consumers and
>rates charged by credit card companies as 'penalties' and 'finance
>charges').  Yet, what you have not noted is how interest rate
>reductions affect working-class *savings* (especially important for the
>elderly): i.e. it lowers their savings and total income (yet, this may have
>been one of the reasons for the interest-rate decreases by the Fed since it
>_forces_ working-class households to take their money out of 'safe'
>savings accounts and use the money to buy stocks and bonds).
>II) Re Allin's [6115]:
> > I would credit the Fed with being smarter than that.  Surely the rate
> > cuts are designed to increase aggregate _demand_.  Of course, if the
> > general macroeconomic conditions are depressed enough the cuts may not
> > be very effective (Keynes and "pushing on a piece of string".)
>I think you are giving the Fed _too much_ credit.   The Fed wanted to
>increase investment -- particularly *stock market*  investment.  Yet,
>the stock market consistently didn't react in the manner anticipated by the
>Fed -- indeed, each time there was a cut in short-term rates Wall Street
>expected it in advance and didn't react favorably to the news.  Yet,
>they continued the same policy even though it was evident that it was
>not working. So, they (unlike the Fed in the early 1980's when they
>reversed course away from monetarist monetary policies intended to
>lower inflation) don't even have the advantage of being pragmatic and
>haven't yet admitted that lowering interest rates *under current
>circumstances* is futile.
>As for whether this policy was intended to increase AS and/or AD,
>I believe that the concentration on the stock markets showed that
>they were focused on the former. Certainly, they didn't have a coherent
>plan for how this would increase consumption spending or
>disposable income (_unless_ it was through the assumption of
>Say's Law: i.e. first investment is increased which increases corporate
>profitability which -- it is assumed -- will lead to increases in aggregate
>supply which will -- it is assumed -- lead to increases in employment,
>income, consumption spending and AD).  To the extent that the Fed's
>policy could be said to affect demand it had more to do with the
>*composition* of demand than the level of AD.
>You say 'if the general macroeconomic conditions are depressed
>enough' ... well, surely they _were_ (and are) depressed enough
>otherwise the Fed Chairman wouldn't have supported Bush's
>tax cut plan.  As for Keynes, it is quite evident that Fed policy has
>not been guided by Keynesianism for many years. Perhaps we
>should call the failure of Fed policy  "The Curse of Lord Keynes"?
>In solidarity, Jerry

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