Re: moore on term structure

[Basil Moore <bmoore@xxxxxxxxxxxx>]

        Warren and Per

        Increases in ST rates will raise interest costs and so will have an
upward effect on prices. But this will occur only in the short run, will
interest costs are increasing. It is a one-shot effect. After firms have
raised their markups on ULC, there will be no more inflationary pressure
from this direction. But to the extent the higher lending rates deter
deficit spending on the part of economic units, they will lead to a lower
rate of AG growth, and so a lower rate of employment creation.


        Warren if nominal rates are held at zero, expected inflation will
lead to negative expected real rates. This will raise long term variable
income asset prices indefinitely, so long as deflation is not expected,
encourage additional deficit spending, and reduce returns on fixed financial
assets. If agents expect negative real returns on fixed financial assets,
why should they buy them, if they can get positive expected returns on real
assets?? So I agree with Per, the target should be zero real rates.

        Basil

















At 08:18 PM 10/24/97 +0200, you wrote:
>In reply to Warren Mosler:
>
>-----
>
>Warren wrote before (replying to Basil):
>>>> First, I personally have difficulty in concluding that any country with
>its own independent currency should support overnight rates rates above 0
>bid.  Nor do I see value in issuing any state securities. Just let excess
>balances at the Fed sit there. <<<
>
>Per commented before:
>>> I am much on the same track, only that I would like to see the REAL
>interest rates, not the money interest rates at the 'zero bid' level. (By
>real interest I mean the nominal interest rate less the rate of inflation in
>an overall Asset Price Index.) The securities issue could be resolved by
>having the Central Bank pay interest on deposits. <<
>
>Warren replied:
>> Perhaps.  Consider the case where nominal overnight rates are left at 0
>bid, and your api has been increasing at 4% for some period.  I am not sure
>that supporting long rates, say, 2% higher, for example, would not simply
>lead to 4% api increases after some lag.  That is, is it possible that real
>rates, however defined, are somewhat independent of nominal rates? <
>
>Per:
>Let us, for the sake of simplicity, restrict ourselves to the case of short
>rates (assuming the gov't has closed down the Treasury and finances its
>deficit by interest-bearing accounts in the Central Bank).
>
>Now, if we start out with, say r = 2%, and the API is increasing at a 4%
>rate. Then the real rate will be "too low" (minus 2%) according to the goal
>of zero real rates that I have suggested. What to do? Raise the interest
>rate! If a 2% interest rate supplies enough liquidity to fuel a 4% rate of
>API inflation, then an interest rate around 3% may restrain the liquidity
>growth enough to get the API inflation rate down to 3%, which would close
>the negative gap. This is how I figure things would work. Whenever the API
>inflation rate tends to go higher than the short-term rate, the short-term
>rate should be raised enough to secure convergence. As the example shows,
>the short-term rate must not be mechanically adapted ex post to the API
>inflation rate. A 4% short-term rate would have led to an "overkill" of
>liquidity growth, perhaps putting API inflation at 1--2% and leaving us with
>the opposite problem of a positive real rate.
>
>Warren:
>> Let me add that my positions on this are only 'guesses,' with no
>supporting hard evidence.  The logic is that interest payments on state
>securities are state (deficit) expenditures.  Therefore, the question is,
>'how can increasing spending (even) via interest payments be deflationary?'
>Of course it
>could be deflationary, depending on different propensities to spend and
>save. But this analysis needs to be carefully examinied as it is a bit
>counter intuitive to have a 'macro' policy of increasing state spending
>(higher long rates) to slow api inflation. <
>
>Per:
>Oh, now I see your point. Well, I have been figuring all this in terms of
>short-term interest rates, not long rates. But this does of course not
>affect the validity of your point. True, high interest rates are likely to
>increase the inflationary pressures from the cost side, and -- in the longer
>perspective -- from the demand side by increasing government expenditure on
>interest payments. But all this is about prices on FLOWS of economic
>activities, not prices on STOCKS. There may be some loose connection between
>long-term flow prices inflation and the stock prices development, but I
>don't think this is an important factor. The problem of interest rate
>management should be viewed in a six months to one year time-perspective,
>and I think there is no doubt that a rise in the rate of interest will
>produce a lower rate of asset price inflation in this time-perspective. Did
>I get your point right? Did I answer to your query??
>
>Wondering,
>Per
>
>
>Per Gunnar Berglund
>Lilla Sallskapets vag 60
>127 61  SKARHOLMEN
>SWEDEN
>
>Voice/fax +46-(0)8-883065
>
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>


Basil Moore, Department of Economics
Wesleyan University
685-2363