RE: Euro Rates Slashed

[larson@xxxxxx (S R Larsson)]

S R Larsson:
>> Can anyone who's a POST-KEYNESIAN on this list explain to me how interest
>> rate cuts can help cutting unemployment, when at the same time budgetary
>> austerity is being institutionalized via the EMU system? I say statistics
>> show there is at least a 9:1 advantage in using fiscal policy to boost
>> investment -> increase employment, over cutting interest rates. Therefore,
>> when interest rates AND government spending are being cut simultaneously,
>> the net result is most likely MORE unemployment, not less.
>> . . .
>
Max Sawicky:
>The U.S. situation would seem to be hard to explain,
>in this context.

I believe the US situation is a good example of wealth-driven private
demand dwarfing the negative effects from public sector austerity. Growing
private wealth means more to borrow on; a healthy financial sector also
improves confidence on the credit market, making creditor lend more than
otherwise even where the only security the debtor has to provide is her
future income. This is where interest rates are interesting, as a regulator
of private consumption rather than private investment. Once banks tighten
credit there will be a downturn in private consumption. When central banks
take interest rates down the effect is hopefully a maintenance of good
future confidence among bankers, which in turn means they do not reduce
lending to households.

The role of the interest rate behind private consumption is generally
underestimated. And yet, it enters virtually everywhere: mortgage loans,
car loans, credit card purchases. With a sharp increase in interest rates
all these forms of spending will nosedive. A conservative guess is that 60%
of private consumption is affected by interest rate shifts one way or the
other (if we include credit card spending). Let's say the sensitivity to
interest rate changes is a mere 10%. If interest rates go up by 1%, then
1/10 of that affects 60% of private consumption. How many jobs would that
affect? How much would creditors tighten credit with relation to a 1%
interest hike? These are the kinds of questions we should be asking, in
order to find out the true impact of interest rate cuts on GDP.

The habit of economists to focus on the relation between interest rates and
investment stems from the IS-LM model, where the level of aggregate demand
is given. So long as the aggregate demand level is taken as given, it is
obvious that the olume of investment depends on the interest rate. But
that's not a very Keynesian approach, nor very empirically orientated.


/srl

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Sven Robert Larsson
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