Re: moore on term structure

["Per Gunnar Berglund" <pgb@xxxxxxxxxxxxxxxxxx>]

 In reply to Basil Moore:

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Basil wrote:
> 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. <

Per:
I see your point and I agree, provided we have invoked a ceteris paribus
condition.

My only objection is that the nominal interest rate does not enter into
properly defined costs of production -- the REAL interest rate does: User
cost of capital = Capital value x Real interest rate -- RUC = V(r - HG/V).
Now, holding gains HG are surely not independent of the nominal interest
rate. We may normally expect that the rate of holding gains is a (negatively
sloping) function of the RATE OF INCREASE in the nominal rate of interest --
at least in the very short run. Whenever rates go up holding losses will
appear, and vice versa when rates go down.

I feel somewhat agnostic about the longer perspective. As Warren has argued,
higher short rates may increase inflationary pressures, which in turn might
push up the longer-perspective HG/V rate. The question is whether this
push-up effect exists and if it does -- how large it may be. If the push-up
effect exceeds the short-rate hike that set it off in the first place,
things may get out of hand with HG/V accelerating more than r was raised.

By your statement above, I got the clear impression that you believe higher
short rates are an effective means to slow down long-term AD growth, and
this would presumably imply that the long-term HG/V rate goes down as well.
So when it comes to flow prices (GDP deflator etc), a rate hike would imply
a short-term inflation push, and a long-term AD slowdown and (maybe) lower
inflation. But when dealing with stock prices, the short-term and long-term
effects would go in the same direction -- downwards. (This should, by the
way, be one of the chief reasons why AD growth will slow down.)

Preliminarily, I am on your side. I have set out my reasons in the latest
post replying to Warren. Both the cost-push and the demand-pull effects will
depend on whether the nominal interest rate hikes will bring about a
non-zero RUC. If r - HG/V is kept steadily at the zero level, there will
neither be any change in capital costs, nor in the "rentier" income from
capital ownership. If capital costs do not change, why should prices
increase? And income doesn't change, why should there be any demand effects?

Basil again (in part):
> So I agree with Per, the target should be zero real rates. <

Per:
Fine we agree. But are you with me on the real rate definition (r - HG/V),
i.e. STOCK real rates? Or are you talking about FLOW real rates??

Best wishes,
Per


Per Gunnar Berglund
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