skip to Main Content

Australian labour market data – mostly discouraging

Today the ABS released the Labour Force data for May 2010 which show that the unemployment rate has fallen by 0.2 percentage points ostensibly, if you believe the press reports and the comments from the bank economists, on the back of continued strong growth in full-time employment. The truth is different. While full-time employment growth was positive it is not accelerating and overall employment growth slowed in May 2010. More importantly, all the fall in unemployment was due to a further drop in the labour force participation rate. So employment growth remains sluggish and is barely keeping pace with the growth in the population. The good news is that aggregate hours worked continued to increase which is reducing underemployment a little. While the bank economists have hailed today’s figures as indicative of an economy “near full capacity”, the reality is that the data is consistent with a broad array of statistics showing the Australian economy is slowing as the effects of the fiscal stimulus dissipate and and private spending remains subdued. It is amazing how a few headlines can distort what is actually going on.

The summary ABS Labour Force results for May 2010 are (seasonally adjusted):

  • Employment increased 26,900 (+0.2 per cent) with full-time employment increasing by 36,400 and being partially offset by a reduction of 9,400 in part-time employment.
  • Unemployment decreased 25,400 (-4.1 per cent) to 600,900.
  • The official unemployment rate fell 0.2 percentage points to 5.2 per cent.
  • The participation rate fell by 0.2 percentage points remained at 65.1 per cent which helped bring the unemployment rate down. Participation is still well down from its most recent peak (April 2008) of 65.6 per cent. So the approximate number of workers that have dropped out of the labour force because of diminishing job prospects (that is, the rise in hidden unemployed) is 96 thousand persons.
  • Aggregate monthly hours worked increased 43.9 million hours(+2.9 per cent) and have now exceeded the July 2008 peak from the last cycle.
  • Total labour underutilisation (the sum of underemployment and unemployment) is down to 12.2 per cent from the February quarter value of 12.8 per cent. The drop is made largely due to a fall in underemployment (from 7.5 per cent to 7.0 per cent) which isn’t surprising given the recovery in working hours. The reality is that when you combine the participation rate effects (hidden unemployment) with the ABS broad labour underutilisation you still have around 13.2 per cent of workers without enough work. That is significant evidence of labour market slack despite the rhetoric that we are approaching full capacity.

This is how today’s data was reported on the ABC news – Full-time work leads unemployment fall. That sounds good. The report said:

Hiring not firing: Unemployment fell to 5.2 per cent in May … Australia’s labour market has surprised analysts again, with unemployment falling to 5.2 per cent in May.

A small fall in the proportion of people looking for work from 65.2 to 65.1 per cent combined with the increase in jobs to lead unemployment down from 5.4 per cent in April to 5.2 per cent in May.

As the analysis that follows will show the actual fact is that the growth in employment barely kept paced with population growth and the drop in unemployment (and its rate) was all down to the fall in the participation rate. Further, employment growth actually slowed this month.

When you combine those facts you will see how misleading the news headline (above) is.

ABS News also recorded the comments from the bank economists. So:

It’s a very strong report with that rise in employment solely driven by full-time employment … “We saw a big rise in the number of hours worked and a significant drop in the unemployment rate so all round a pretty positive report.


Not only are employees holding onto and finding new jobs, but existing workers have got back the bulk of the hours they lost in the GFC


We do think the RBA will sit on the sidelines for the time being, that said we are expecting another two rate hikes by year end.

So the bank economists are predicting further interest rate rises on the back of a weakening labour market! That about says it all.

The Sydney Morning Herald story on the data release carried the headlines Jobless rate falls , which again presents a positive take on things.

They quoted the Prime Minister who said “We now have about half the unemployment level of the United States, half the unemployment rate of many countries in Europe”, which is a fairly inaccurate statement. Not only does this assessment fail to take into account the participation effects I will discuss presently but the broad labour underutilisation rate (unemployment and underemployment) in Australia was reported today to be 12.2 per cent and if you add about 1 per cent for hidden unemployment you get 13.2 per cent. The comparable US figure is around 16.8 per cent. That more correct comparison puts things in different light.

Employment growth slowing but positive

The following graph shows the month by month growth in full-time (blue columns), part-time (grey columns) and total employment (green line) over the last 12 months to May 2010 ysing seasonally adjusted data The overall picture is mildly positive. The sample period covers the latter parts of the downturn (May 2009 to August 2009) as full time employment growth was negative and part-time growth was mostly positive, which kept a lid on the overall employment losses although the slack showed up in lost hours of work, which was a notable feature of the downturn.

By September 2009, the effects of the fiscal stimulus package introduced in February 2009 were now evident and employment growth started to pick up quickly with growth in full-time employment signalling renewed optimism. In the more recent period, full-time employment growth continues to be positive but is slowing as part-time employment continues to fall.

While employment growth remains positive it has slowed in the last month. It is clear that the impacts of the fiscal stimulus, which drove GDP growth in the March quarter (see Australia GDP growth flat-lining) are now dissipating and private spending is not yet strong enough to really push the labour market to the next level of recovery.

So the picture is far from rosy although the additional full-time work is pushing total working hours up.

Unemployment trends

The official data shows that unemployment fell by 25,400 (-4.1 per cent) to 600,900 and the official unemployment rate fell 0.2 percentage points to 5.2 per cent. This is being hailed as a wonderful result and indicative of the underlying strength of the Australian economy. Standby for politicians to start saying we are close to full employment as a result of this month’s data.

Well nothing could be further from the truth. The following Table shows you what is really going on. It calculates the impact on the labour force and unemployment of the drop in the participation rate (down 0.2 percentage points). First, I computed the civilian population (by dividing the labour force by the participation rate).

Second, I computed the Labour Force with April participation rate by multiplying the Civilian Population estimate in May 2010 by the higher April participation rate. So given growth in the underlying population, if the participation rate had not dropped the labour force would have been 27.8 thousand workers larger in May 2010 than the official estimate. Most of those extra workers entered the ranks of the hidden unemployed.

Third, I revised the unemployment rate estimate by adding the 27.8 thousand workers to the May pool of official unemployment (600.9 thousand) and expressed the new higher estimated pool as a percentage of the upwardly revised Labour Force. The revised estimate of the unemployment rate is now 5.4 per cent for May 2010 which is unchanged from the official April 2010 estimate.

Conclusion: Almost all the fall in official unemployment and the unemployment rate was due to the participation rate contraction. This is not an improvement at all. It is just shifting the unemployed from the official side of the line (in the Labour Force) to the unofficial (hidden) side of the line (Not in the Labour Force).

You just cannot conclude that the economy is robust when you simultaneously have slowing employment growth and declining participation.

So how much difference has these participation effects made over the course of the downturn? The peak participation rate in the recent period has been in April 2008 (65.6 per cent). The participation rate is currently at 65.1 per cent. I simulated what the unemployment rate would have been if the participation rate since April 2008 was constant at that peak value.

The following graph shows the results. The blue line is the participation rate-adjusted unemployment rate (%) and the green line is the official unemployment rate. The difference between the lines is the participation rate effect on the labour force (and hence unemployment) as the participation rate fell below its peak. It indicates the hidden unemployment rate since April 2008.

While the official unemployment rate is estimated to be 5.2 per cent in May 2010 and everyone is crowing happily about that, the participation rate-adjusted unemployment rate would be 5.9 per cent. Quite a different story indeed.

Broader labour underutilisation

The following graph shows the movement since February 1978 to May 2010 (quarterly data) in the ABS Broad Labour Underutilisation rate (dark blue line) and their measure of underemployment (light blue line). The difference between the lines is the unemployment rate.

First, you can see the steady rise in underemployment as the economy grew after the 1991 recession. The economy was increasingly reducing unemployment by the creation of part-time work which still rationed the hours available relative to the preferences of the workers (who wanted more). The fact that total underutilisation didn’t scale the heights reached at the peak of the 1991 recession is due to the relatively small rise in the unemployment rate this time.

As you can see underemployment rose more sharply in the current downturn than it did in the 1982 and 1991 recessions. Almost all the labour slack in the 1982 recession was associated with rising unemployment. Underemployment didn’t really become a major issue until the 1991 recession.

The following graph shows the movements in the ABS Broad Labour Underutilisation rate measure since the beginning of the downturn (February quarter 2008) for males (blue line), females (green line), and total (red line). Typically, females have been the victims of the hours rationing due to their over-representation in the service sector. A notable feature of the current downturn is that underemployment has broadened its impact to embrace males. You

The following graph my 3-recessions graph for broad labour underutilisation (as measured by the ABS). It compares how quickly the broad labour underutilisation rose in Australia in the 1991 recession and the current episode. The broad labour underutilisation was indexed at 100 at its lowest rate before the recession in each case (June 1981; November 1989; February 2008, respectively) and then indexed to that base for each of the quarters until it peaked. It provides a graphical depiction of the speed at which the recession unfolded (which tells you something about each episode) and the length of time that the labour market deteriorated (expressed in terms of the unemployment rate).

The different behaviour in the current downturn is now starkly contrasted to the way the last two major recessions unfolded. You can clearly appreciate how harsh the protracted meltdown in 1991 actually was.

Hours worked – the good news

While total hours worked in April fell by 8.3 million hours (-0.5 per cent) which was on top of a fall in March of 10 million hours (-0.6 per cent), there was a sharp rebound in May – Aggregate monthly hours worked increased 43.9 million hours(+2.9 per cent).If the May figure was weak I was prepared to conclude that the trend would be weakening but the positive trend is now well-defined which is good news.

The following graph is taken from the the ABS data and shows the trend and seasonally adjusted aggregate hours worked indexed to 100 at the peak in February 2008 (which was the low-point unemployment rate in the previous cycle).

You can see a very flat V-shaped recovery with a positive trend – the national economy overall has now gone past the peak of July 2008 which is good news and will drive down underemployment.

State by State

Last month I considered the claim that had started to appear in the media as to whether the recovery phase was defining a two-speed economy where the “mining” regions (Western Australia, Queensland and Northern Territory) were driving growth and the old manufacturing areas (NSW and Victoria) were stagnating.

This is also relevant in light of the current political fiasco where the mining companies are resisting the introduction of a modest resource rent tax (stupidly terms a super profits tax by the Government) and spending millions on misleading advertising. The mining lobby has somehow managed to convince people that the industry is huge (it is not), that is saved us from the global financial crisis (it did not at all – it contracted more than most industries) and the tax will turn us into a communist state [if only! (-:]

Anyway, in the analysis last month there was no evidence to support two-speed hypothesis. The states with significant exposure to mining were not recording as strong employment growth.

I am just monitoring these trends at the moment. The following graph shows the percentage employment growth for the states and territories for each of the last two years (to May). There is nothing special about the periods chosen – just to correspond with the latest observation. The choice doesn’t really change the message.

You can see that the strongest employment growth is in the Northern Territory (although it is a tiny labour market). The old manufacturing stronghold of Victoria (VIC) and the Australian Capital Territory (ACT) are next.

The strong employment growth in the ACT, given it is a public sector economy (seat of government and main government departments are there) reflects the benefits of the fiscal stimulus and the modest expansion of government. Remember not to get tricked by scale. The ACT is a much smaller labour market in absolute terms than NSW and Victoria.

In the most populous states (NSW, VIC and QLD). NSW and Victoria are the manufacturing strongholds and have very little exposure to the mining industry. Queensland has some exposure to the mining industry clearly but also is probably benefiting from domestic-sourced tourism as our exchange rate appreciation makes holidaying abroad more expensive.

Importantly, states with significant exposure to mining like Western Australia are not recording strong employment growth,

So overall, while this analysis is crude, the data does not indicate a two-speed economy is emerging and doesn’t suggest any primacy in employment growth in the mining states. More detailed industry analysis will be available next week when the ABS publishes the detailed labour force data for May 2010.


While the business economists are claiming that the labour market is strong the facts are somewhat different. There is some growth especially in full-time employment and that is a good sign because it is contributing to the sharp increase in aggregate hours worked. This impact, in turn, is helping bring down underemployment.

But employment growth slowed overall and is barely keeping pace with population growth. Further, the usual signs of a strong recovery (rising participation) are absent. In fact, in the last month, the participation rate fell.

The combination of a slowing employment growth and falling participation do not usually augur a dynamic and fast growing economy. Taken together with the other data we are seeing on housing etc, the tentative conclusion is that growth overall is very weak. The National Accounts data for the March quarter clearly showed that without the fiscal stimulus we would have been in recession. That stimulus is being progressively withdrawn now and there is no sign that private spending is really ready to step up to the plate.

The other thing to note is that the fall in the unemployment rate (and unemployment) was almost all due to the falling participation rate. So we have substituted hidden unemployment for official unemployment. Given both cohorts would accept a job if one was offered to them, the overall wastage of productive labour remains the same.

You cannot escape the conclusion that the boost provided by the fiscal stimulus is waning.

Given today’s data and related data releases over the last few weeks, I am still of the view that a further fiscal expansion is required – and should be directly targeted at public sector job creation and the provision of skills development within a paid-work context. That would be a great boost to low inflation growth.

That is enough for today!

Spread the word ...
    This Post Has 164 Comments
    1. I am amused by all this. It seems you are talking across purposes as traders promoting their proprietary ideas. Basic economics with circular arguments, no clear assumptions and evasive hypothesis that shifts when needed to bargain the outcome. Half truths………..Discipline! Who Iam talking about? They know!

      One last thought. Vertical generation is a process about quantities based in propensity multiplier and horizontal allocation is a process about price differentials based in preference choice. Both happen jointly and interact with a covariance structure. As about finance of private spending projects there is a whole capital structure theory based on Miller-Modigliani, benefit/cost assessment and “pecking order” allocation subject to asymmetry.

    2. Scott,

      the government does not need to spend “first”.

      This is again a stock/flow issue. The stock of money does not need to increase or decrease in order for the government to create any given flow of spending.

      As long as there is even $1 of surplus cash in the economy, the government can sell $1 worth of bonds, and then spend the dollar. Wash, rinse, and repeat.

      That excess dollar can generate an arbitrary level of deficit spending.

      Alternately, the government could add a dollar and then sell a bond, and repeat that process.

      Both of the above processes are equivalent.

      Or the government could increase the supply of dollars. The government can do all three.

      Which is “natural” is completely subjective. Whichever you prefer is natural.

      That’s not an economic argument for a zero FF.

      You need to make an economic argument — that a zero FF will promote employment, or increase output, or improve social welfare somehow. You don’t make a radical change like this because you happen to have a personal preference for option 3 versus option 1 or 2. That is the intellectual equivalent of favoring a proposal because it rhymes.

      The only real argument presented in the paper is that it reduces rentier incomes, which is fallacious. I wonder why you couldn’t talk some sense into Randy Wray (and our host) about this. And the same goes for many of the other PK commentators.

      And as you agree that zero FF would not reduce capital income, you have no argument for doing it — as far as I can tell.

      But I would be interested in hearing any economic arguments in favor of this. Perhaps there are some.

      And still, the question remains — what do you think would happen to equity returns if FF was permanently set to zero? What do you think would happen to 10 year debt? Would it be, as anon argues, that interest rates would only reflect credit risk, and therefore your mean return will be zero? Would the mean equity return increase or decrease?

      This whole debate highlights the danger of making macro deductions based on stereotypes and rules of thumb. For every “rentier” that is receiving interest, there is another rentier paying interest. Lowering a firm’s interest costs will increase the firm’s dividend payout. Giving a landlord lower mortgage rates increases the landlord’s net rental income. So in aggregate, capital’s share of income from all sources will not increase or decrease as a result of FF movements. And households are free to purchase any asset, from bond funds to equity funds to REITs. They will shift their portfolios, bidding up the price whatever asset class happens to be subsidized, and bidding down the price of the asset being penalized. These shifts will counter the shifts the government is trying to create, so that total return will remain remarkably resistant to government attempts to control yields.

      For purposes of distribution, what you want to look at is the total income of the household, not the instrument that the household purchases with its income. Taxation is how you reduce inequality.

    3. Not sure of a few things, though I think I am with anon on this.

      There is a high chance that corporate credit market yields will come down. If the 5y corporate spread is 100bps, and the 5y govt bond yield is 4%, high chance that in the no bonds scenario, the corporate bond yields are something like 1-2%.

      There is a historic proof of this. In the 70s, the banks lost to commercial paper funding because producers discovered that it is a cheaper source of funding and the interest rates on this was between the T-bills rates and the bank loan rates.

    4. RSJ @ 9:10,

      There is a lot of literature in Modern Money starting with Minsky regarding interest rates and the effects of central banks making rate moves. Don’t have them with me but have seen a lot on it. Plus there is enough material on this blog, Bill’s books as well on the effects of interest rates. There is a lot out there!

    5. Some clarifying points.

      1.The growth term of nominal yield rates decreases asymptotically to the CB lower bound as the short term declines to the zero interval. (What is the growth rate over night?).

      2. As the time term of the security extends there are additional factors to the risk free term including credit risk (with an expected shortfall term), interest risk with a probability of duration and current duration calculation, exhange risk, inflationary expectations, etc. THe government looses control capability with rising maturity in primary market auctions and with duration in secondary markets regardless of substitution options. I have mentioned all this before in other comments. Notice that there is even a purchasing power term which rises asymtotically as the expected duration declines.

      3. Excess dollar, wash, rinse and repeat. How did the excess dollar come about? If the government can spend by crediting accounts or printing cash why discuss a seperate increase in the money supply? How this will happen? The government will borrow from itself via the CB? Is this optimal? Optimization requires least effort! Natural, implying less resources used, is the least effort!

      4. As I have argued in an earlier comment in a previous blog post all taxation is mainly distributional (preference) at discretionary tax rates in nature and should not be confused with spending injections of fiscal stimulus and endogenous fiscal spending (propensity) which is mainly vertical in nature. It is not proper mix the analysis in terms of a deficit distinction. The tax rates upon income (non lump sum) including tha rates on sales and the automatic fiscal spending coefficient modify the income multiplier and the fiscal spending injection is either an exogenous stimulus based on state purchasing plans or can be viewed as an automatic feedback to a demand failure to achieve full employment.

    6. Ramanan,

      I know that there are many words out there, but I don’t think the word “equity” is mentioned once when discussing yields. Neither is opportunity cost, or endogenous capital growth. Strange. I’d like to hear what Scott thinks would happen to equity in case FF was permanently set to zero.

    7. corporate paper is not 5 year debt. Paper is short term debt — e.g. up to 270 days.

      You actually gave an example of the government attempting to control yields (by making it illegal to pay interest in deposit accounts), and households responded by buying money market funds that paid a positive yield. I.e. this is an example of the government failing to control interest rates. The fact that banks must compete for deposits is also overlooked — e.g. deposit rates were higher than mortgage interest rates in Australia recently. Even though the banks are captive and can be forced to bear excess reserves, households are not forced to hold deposits or to buy corporate bonds. They can always buy equity, or invest in funds that buy equity and issue shorter term obligations, and in this way, shorter term yields are pushed up by the equity yield whenever the government tries to push the shorter term yields too low.

    8. You say nobody talks about equity.

      Yet the theory of capital structure discusses the options of financing with equity as I have mentioned several times. The question is if there is an advantage to order the means of finance. What is your hypothesis and why?

    9. P,

      By “nobody” — I was referring to the MMT camp. It’s really bizarre, as I asked a question about what would happen to equity, and got answer about 5 year corporate debt, and this was supported by a “historical precedent” using commercial paper (!).

      In terms of my own hypothesis — I want to first hear what Scott and others believe will happen to equity yields if FF is permanently set to zero.

    10. Why wait for Scott? Given your interest and discussion in the topic I am sure you must have hypothesis behind it. I do not challenge you. I am interested to know. For example is there a preference for a firm to issue equity first, second or last, the others of course being retained earnings and borrowing. For example Miller-Modiglianni originally thought it made no difference and then gave an order of preference in favor of debt because of the tax treatment. Sources of imperfection also matter as the “pecking order” hypothesis which is based mainly on asymmetry. I have been looking of how the other sources affect the order. Also, does the order of issue affect the order of portfolio allocation of the demand side, including financial intermediaries?

    11. Because, P, then we get into a debate about my theories, whereas I am trying to pin down the MMT view. The reason I asked Scott specifically was that he at least acknowledged that capital income does not rise or fall when FF changes.

      This is a serious breakthrough vis-a-vis what Bill or Randall Wray believes. In fact, Scott is the only one who acknowledged this AFAICT, and it’s a testament to his integrity that he is willing to follow the data where it leads.

      It would require a lot of fancy footwork to argue that yields from all assets would fall when FF is zero while simultaneously believing that capital income would remain constant.

      I want to see that footwork in action. And who knows, perhaps I would learn something.

      But I will post something about what I think in some other blog post here.

    12. We all learn something if we have an open mind, assumptions and a hypothesis to propose which others can help us correct. The purpose should not be to challenge anybody to display their fancy footwork. We are not traders of proprietary ideas to score points but free thinkers wanting to share. We are not working to promote ideas seeking a reward but donating idea/opinions expecting grace in return. In a summary, we should be a community of thinkers not a market of promoters.

    13. I agree, P, so let’s find out what the MMT proponents believe will happen first to capital’s share of income and second to equity returns if FF is permanently set to zero.

    14. RSJ, perhaps I am naive, but what difference does it make? It seems to me that this is a market decision and not something that the government (including the CB in government should be involved. As I understand it, interest rate setting by the CB was a feature of convertible fixed rate currency that no longer applies. The government now sets rates as a matter of financial engineering, and in doing so uses unemployment as a tool. Why not just get the government out of the business (including no bonds). This would would be tantamount to letting the overnight rate fall to zero, considering that fiscal policy to produce full employment with price stability would pretty surely involve a constant deficit, hence excess reserves.

    15. RSJ,

      There are some papers in the PK stock flow consistent models which talk of equity. If you have jstor access you can try Kaleckian models of growth in a coherent stock-flow monetary framework: a Kaldorian view by Wynne Godley and Marc Lavoie.

      Here is the abstract

      Abstract: This paper presents a demand-led growth model grounded in a coherent stock-flow monetary accounting framework, where all stocks and flows are accounted for Wealth is allocated between assets on Tobinesque principles, but no equilibrium condition is necessary to bring the “demand” for money into equivalence with its “supply.” Growth and profit rates, as well as valuation, debt, and capacity utilization ratios are analyzed using simulations in which a growing economy is assumed to be shocked by changes in interest rates, liquidity preference, real wages, and the parameters that determine how firms finance investment.

    16. Ramanan, I know this model — but what are your beliefs? Do you argue that if FF were to be permanently zero, that, either

      a) Capital’s share of income would change, or
      b) It would not change

      In case of b), which assets would see increasing returns and which assets would see decreasing returns? Why would households buy the assets with falling returns and not the ones with increasing returns?

      In case of b), how would it change and why?

      This is not a trick question — I am honestly trying to figure out what you believe. I know what Warren M. believes — he believes a) would decrease, and that households would park investment funds in bank deposits and accept the low rates — good that he owns a bank! But what do you and Scott believe?

    17. RSJ,

      I don’t think that setting the FF permanently to zero will necessarily affect capital’s share of income. I thought I had said that already. I think other policies are necessary if that’s a goal.

    18. RSJ, isn’t it that at the very least FF rate at zero will decrease the capital’s share of income simply because the flow of income from the government to private sector will be lower. With regards to the rest (i.e. private sector) you seem to be right about pure redistribution of capital income between different capital instruments without any affect on total volumes.

    19. RSJ,

      It is time that you come forward and present your position on equity and the capital’s share with assumptions, hypothesis and why. This way you can get some response to your concerns. It is not clear to me what is your position. Challenging others is not enough, share with us your views…… will also help yourself if that is your purpose.

    20. “I don’t think that setting the FF permanently to zero will necessarily affect capital’s share of income. I thought I had said that already. I think other policies are necessary if that’s a goal.”

      You did say that, but I think you contradicted it.

      My view is that it isn’t a question of being a policy goal; it’s one of it being a very likely outcome of the zero rate policy.

      First, rates on risky fixed income assets equal the risk free rate plus a credit spread.

      So if the risk free rate drops permanently to zero, it seems very likely that rates booked on new risky assets will drop. That’s not to say there won’t be some adjustment in credit spread risk premiums, but it’s not logical to expect a complete offset as an outcome. I thought you agreed with this more or less.

      Second, expected return on equity assets is equal to the risk free rate plus a risk premium. Again, for the same reason as fixed income assets, it seems very likely that expected and realized equity returns will decline as a result of dropping the risk free rate to zero. It’s not logical to expect risk premiums to increase as a complete offset.

      I thought you agreed with the gist of this as well.

      Finally, some people seem to be under the impression that a decline in the fixed income component at the macro level must be offset by an increase in the equity income component. This is quite funny, because it reminds one of the “Treasury view” of government deficits. Obviously there is an output/income identity in the national accounts. But an identity doesn’t mean things don’t adjust along the way – something which Krugman had to point out to the Chicago school a while back. In this case, zero risk free rates are a deflationary income shock that would result in likely relative price declines and relative upward wage pressures through competitive forces – because without these further adjustments, return on equity would be too high (and too attractive for new entrants to ignore) relative to fixed income returns.

      (I’d be interested in an example or two of those necessary policies you refer to.)

    21. P.S.

      “I don’t think that setting the FF permanently to zero will necessarily affect capital’s share of income.”

      “necessarily” is a bit of a hedge.

      Nothing that is uncertain is necessary. But wouldn’t you agree it’s likely in this case?

    22. “This is not a trick question — I am honestly trying to figure out what you believe. I know what Warren M. believes — he believes a) would decrease, and that households would park investment funds in bank deposits and accept the low rates — good that he owns a bank! But what do you and Scott believe?”

      Let’s look at Japan – zero rates and the public parks their funds in the postal bank – good that the public there owns (sort of) a bank. I can’t see how capital’s share of income (vs. composition within capital – rents, interest, profits) would necessarily change, unless other political constraints are put in place.

    23. Anon,

      It is not clear how the risk free rate will go to zero without an asymptotic adjustment for the growth rate, given the term structure. For example, the LT rate has a risk free term which is equal to the trend growth rate and this term declines in importance accordingly as we shorten the maturity and duration of the security in question. THIS HOWEVER DOES NOT ALTER YOUR POSITION, SO WHY ARGUE ABOUT THE RISK FREE RATE? The CB controls only the very ST for which the growth term is insignificant. The question is whether, the income lost from non payment of interest comes from replacement of reserves and cash issued rather than LT bonds when the fiscal authority net spends. It is possible that lower ST rates from Monetary Policy can result in higher investment spending and profit income can replace the lost income from public debt. However, this depends on how responsive is investment spending to ST rates given “animal spirits” (beliefs) and MEC and limitations imposed from collateral asset values and financial leverage of private spenders. So what happens is MAYBE. Unless anybody else has a clearly stated hypothesis with expicit assumptions we cannot CLARIFY WHAT ARE YOU GUYS ARGUING ABOUT.

    24. Why are you trying to incorporate growth in fixed income returns? Fixed income investors get compensated for credit risk, interest rate risk, inflation, and inflation risk. Not growth.

      And what is compensated assumes its a market determined rate.

      The short term risk free rate is not a market determined rate. By construction, there is no credit risk, and investors are not compensated for the other risks because pricing is not market determined.

      Furthermore, assuming the central bank commitment to a permanent zero short rate is credible – and that is the working assumption here – there is no interest rate risk. So forward rates should be the same as the short term cash rate, and the yield curve should be identically flat and zero rate.

    25. Anon,

      I agree with you on the fall of other interest rates. As you pointed out, it will also lead to a drop in costs. However, I think that producers may just increase the markups. I don’t see why the class which earns interest income will not earn less – its income will go down, and I don’t think such a thing is inconsistent with what I have seen in Post Keynesian Economics.

      As far as equity is concerned, I guess in advanced economies, equity has already been thought of as the costliest route and avoided as much as possible. As far as corporate debt is concerned, I don’t see why investors’ animal spirits won’t go high and soon, they will find that its the place to invest if yields remain high and hence this class with bring down the yields. This class may also give banks a run for their money.

      So I agree with your comments.

      As far as interest rates are concerned, its the rentier class which lobbies for higher rates because that gives them higher incomes. The central bank is just dodging its objectives of full employment and pressure of the lobby group.

    26. “So I agree with your comments.”

      What fine judgement you have :)

      I’m wondering what the MMT’ers expect retired people to do. Invest in equities only? “Rentiers” include retirees. Last time I checked, that includes common folk in addition to fat cat bankers. I’d like to know more about the Mosler plan for that.

    27. P.S.

      I get the distinct impression that a core part of the MMT agenda is to punish rentiers with a broad brush.

      I’m not sure that’s a very healthy strategy. In fact, I’m quite sure it’s not.

    28. “I’m wondering what the MMT’ers expect retired people to do. Invest in equities only? “Rentiers” include retirees. Last time I checked, that includes common folk in addition to fat cat bankers. I’d like to know more about the Mosler plan for that.”

      The most sensible approach is to have a living state pension, which is exactly the same as paying index linked yields on gilt, but it cuts out the financial middleman.

      And then yes they would have to invest in equities – you know real business that generate real profits and pay a real dividend, while at the same time employing real people. That would get businesses away from the stupid asset stripping leverage dash for cash capital growth system we seem to have ended up with.

    29. “I get the distinct impression that a core part of the MMT agenda is to punish rentiers with a broad brush.”

      MMT is just a theory of how money works. It gives some interesting insights – that a sovereign nation is not financially constrained and that the exchange rate is another buffer against systemic shocks that shouldn’t be locked out.

      How it is used depends on your ideology. Whatever the ideology, the way money works stays the same.

      The rest is politics. What are the arguments for rentiers earning money off other people’s backs. I can see an argument for rentier getting paid if their investment provides jobs for other who cannot create one themselves. I can see an argument for a rentier getting paid for providing decent housing for people to live in. I can’t see an argument for them getting paid for dominating a monopoly resource or constraining access to ideas or other systems of production (copyright on ‘old’ material for example).

    30. “So if the risk free rate drops permanently to zero, it seems very likely that rates booked on new risky assets will drop. ”

      Wouldn’t the adjustment come through the shift away from monetary policy to the fiscal taxation regime.

      For example you could have 0% interest rates and a land value levy charged to freeholders that the central bank adjusts (since land is a monopoly resource and the basis of all production – mostly in the form of housing). If that levy was tax deductible then you would see roughly the same effect as having interest rates set positive but it would affect a different demographic.

      A policy rate is just a tax at the end of the day.

    31. “What are the arguments for rentiers …”

      Rentiers are savers.

      What are the arguments for punishing savers?

      Why should savers who outsource their investing be punished for it?

      Do you have to own a steel mill in order to save without being punished for it?

    32. Absolutely there is a contradiction in the view that capital income’s share will remain constant and the view that the expected return — for all maturities, including equity, are set by the expected FF over that time horizon.

      Fortunately, it is clear which theory has empirical support. Capital income does not decline when rates fall — in some countries it even increases. Moreover, the profit rate is the growth rate of the economy — this is the Cambridge rule. You learn this in freshman macro when you study the Solow model, or if you want to be heterodox, you get the same result in Harrod’s knife-edge model, the Goodwin predator-prey model, or even Kalecki’s markup model. A more modern version is from Romer’s 1990 endogenous capital growth model.

      They all have the same result — that the profit rate is equal to the growth rate. OK, that is theory, but what about evidence for the golden rule? I once remember reading a paper called “Limits to Central Banking” by either Lavoie or Godley — I’m sure Ramanan has the reference ready — in which they applied an HP filter to equity returns and long term bond returns and found that they supported this.

      You can do you own analysis. If you are looking at long time periods, then long term bond yields and long term equity yields are equal, both ex-ante and ex-post, and both are equal to the NGDP growth rate over the period.

      We can get into a whole discussion as to the absurdity of the model that long term rates are expected fed-funds. First, fed funds is not an investor rate, but an interbank rate. The 0 day interest rate for investors is MZM own rate, so to be consistent, you should be arguing that expected values of MZM are what counts.

      The actual mechanism by which FF affects other rates is arbitrage by the banks. Now if banks had no capital requirements and no regulatory requirements, and could borrow without collateral at zero interest rates, then they would buy up all the assets. In that case, yields would be zero, or rather undefined. Only in that case can you argue that expected FF = interest rates.

      But in order to prevent that, we impose costs on banks in terms of setting aside risk capital and we limit what types of assets they can hold. So banks cannot arbitrage with FF alone — the true cost of arbitrage is FF + other costs + regulatory limits — not just FF. When those other costs are too low, then capital income does not fall, it gets re-routed into the banking system, away from one set of rentiers and towards another.

      So I would say that the natural zero day rate of interest is zero — checking accounts should pay zero — but the natural fed-funds rate is not. Instead, talk about FF + other costs. Those costs should be such that the total cost to the bank of extending a loan is equal to the expected growth rate of the economy. Depositor banks should only be holding loans they make to term, and should not be allowed to purchase credit-market assets. And one way you can accomplish this is to impose asset taxes as well as other extra profit taxes on banks to prevent them from using their CB backing in order to obtain greater profits than the productive economy.

      Absolutely agree that punishing rentiers is bogus objective. The problem is not a shrinking of wage income, but the distribution of that income. And you don’t care if a CEO gets paid excess wages or if they receive excess dividends. What you should be trying to limit is economic rents, whether those be from capital income — i.e. when bank marginal costs are too low — or from wage income paid to top earners.

    33. “the view that the expected return — for all maturities, including equity, are set by the expected FF over that time horizon”

      You remain confused. I’ve said nothing like this at any time.

      You don’t seem to grasp the concept of a risk premium over the risk free rate.

      “We can get into a whole discussion as to the absurdity of the model that long term rates are expected fed-funds.”

      Again, you are confused. I would never say this about the existing active fed funds anchored monetary policy.

      But it certainly applies to a system in which the government effectively abandons modern central banking and commits to a permanent zero rate on banks reserves.

    34. “Moreover, the profit rate is the growth rate of the economy — this is the Cambridge rule.”

      I don’t have a problem with that. It may be bullshit for all I know, but I don’t object to it.

      What I know for certain is that I’ve said absolutely nothing that contradicts it, so I don’t know why you bring it up.

    35. P,

      In terms of what I believe, I would say that “to first order” — e.g. in a toy arbitrage-free model — the equity returns are endogenous and that the discount rate for equity is the expected growth rate of the economy.

      The NPV is not discounted by the interbank rates, but by the overall expected growth rate. So that, if you have a firm, it will continue to expand its capital stock, and as it does so, the return on capital — for that firm — will fall up until it hits the overall expected return. I.e. as an axiom, any expansion of capital must be because it is earning a return greater than the overall return, and that the capital stock will continue to expand until it hits the overall return from below.

      With many overlapping firms or varieties of capital, new ones are being born, encounter increasing returns, then decreasing returns and hit the expected growth rate from above. So the market value will be determined by that terminal capital size at which point expanding the capital stock will is no longer profitable. So say the overall growth rate is 5%, and the small firm now has 1 unit of capital that yields 6%, and if you increase that to 10, you max out at 10% and then you keep increasing it until you hit a average profit rate of 5% when you have 20 units. If this whole process is expected to take 10 years, then the market value would be the present value of $20 discounted at a rate of 5% over 10 years, as you are being promised delivery of 20 market consols in 10 years, each paying 5%.

      None of this has anything to do with interbank lending rates.

      For shorter term maturities, you can get an arbitrage-free yield by assuming that the firm can speed up the process of growth if it takes out a loan rather than funding itself via retained earnings, and this will increase its equity value. On the other hand, the firm must repay the loan, decreasing its market value. In an arbitrage-free context, this change in capital structure will not cause the equity value to either increase or decrease, and from this you get an increasing function of the interest rate as a function of the repayment time.

      With a distribution of firms, you can still calculate an expected yield for each maturity. All yields will be discounted by the overall growth rate of the economy together with the rate at which the marginal product of capital diminishes.

      That will get you a simple, idealized model of equity returns and a yield curve — an arbitrage-free model. Not the actual curve, which is subject to government forces. This is perfect future knowledge model, too. I.e. even ignoring risk, a growing economy with growing firms will have a positively sloped yield curve and a non-zero interest rate.

      We do have banks and they do arbitrage with CB backing, by purchasing longer term assets from shorter term funding. But simultaneous to that, this encourages debtors to shift their capital structure to take advantage of the lower funding costs, undoing some of the arbitrage. Whatever remains is an economic rent taken out of the productive economy and put into the banking system. Such a rent will eventually cause the growth rate of the economy to fall. So in terms of the “natural” rates of interest, they should prevent any economic rents from going to the financial system. And this works in the opposite direction as well — when FF is hiked too high, you get a banking crisis. The total costs imposed on banks should be neither too high nor too low, but in line with the cost of capital of the productive sector, so as not to interfere with arbitrage-free interest rates

      Now, in addition to this toy model, you would look at all sorts of psychological, behavioral and institutional factors — that is fine, but at the end of the day, you do not need to rely on these factors to explain either the equity returns or the basic form of the yield curve, or the fact that equity rates average out to be the economic growth rate for developed economies. Or the fact that for any particular firm, the internal rate of return is greater than the overall market return — by about 3%. These stylized facts can be modeled well by a simple overlapping capital model, and that’s how I tend to view things as a baseline case.

    36. Anon, “I’m wondering what the MMT’ers expect retired people to do. Invest in equities only? “Rentiers” include retirees. Last time I checked, that includes common folk in addition to fat cat bankers. I’d like to know more about the Mosler plan for that.”

      In a market free of interest rate setting by a small group of technocrats, retirees will do what everyone else does, that is, act in whatever they consider to be in their best interest vis-à-vis free market opportunities. Isn’t that what a free market is about?

    37. Anon, At your comment of@1:04,
      Who are you addressing? If it is a response to my comment you are obviously confusing what I say. I suggest you read it more carefully since I clearly stated that the growth rate is not relevant for the very ST rate which can be controlled by the CB. AS about the longer term rates I have repeatedly presented my hypothesis even mathematically with a more elaborate and complex presentation in my theoretical work. I even pointed out to you that your preoccupation with the rates is not essential for what it seems to be your point regarding the lost income from public debt. PLEASE STATE CLEARLY YOUR HYPOTHESIS AS I HAVE ASKED RSJ TO DO. HTEN YOU WILL RECEIVE AN ANSWER FROM ME, AGREEING OR NOT.

    38. Anon, you are hopelessly confused. The “risk-premium” is just credit risk, and this goes away when you look at expected return. Obviously for any given issuer, they will be charged a premium due to the possibility of default. So what? We are talking about the return ex-post — that is what investors are really buying. In terms of the other comments, you can review your own posts earlier in this thread.

      Under no circumstance past, present, or future will the return ex-post be equal to expected interbank rate movements. The profit rate will be the growth rate of the economy over long time periods, and the only question is 1) how much of that is diverted into the financial system as economic rents and 2) how will investors shift their holdings to counter the government imposed subsidies and penalties. It may be that banks buy all the assets and everyone invests by buying the banks — that is one extreme possibility. But what is more likely is that equity in general grows and fixed instruments in general shrink somewhat. I don’t think they would shrink too much, since you can create mutual funds to buy equity and issue debt claims to investors, if investors prefer to hold debt.

    39. Anon: “I get the distinct impression that a core part of the MMT agenda is to punish rentiers with a broad brush.”

      From what I understand about MMT, I’d say instead that a core part of MMT is to balance output (growth), employment, and price stability so as to reduce/eliminate foregone opportunity and inefficiency in the use of resources, natural and human, while at the same time keeping the currency/price level stable. A by-product of this would be to increase investment opportunity. If it is an objective to “reduce rentiers’ income,” it is in the sense of replacing unproductive rent-seeking with productive investment. What am I missing?

    40. RSJ,

      You have presented assumptions and a hypothesis, so we can talk. I am not sure I follow all of it but here are some observations.

      1. I find your assumptions regarding the ‘toy” model rather unrealistic including the arbitrage free arguments, perfect knowledge, etc. I understand however, that this is a first pass.
      2. The analysis regarding the role of the growth rate and rents in estimating equity values is something I can AGREE with some qualification of the degree of persistence regarding market power and the effects from imperfection and complexity. There can be persistent equity differentials among firms.
      3. It is not clear if you have an order of the sources of financing of investment plans as the capital structure theory debates. Does the firms in your scenario use an order such as retained earnings, debt and equity finance or some other and why? For example,does your hypothesis accept that are benefits from taxation, financial leverage or the financing mix is neutral? How sources of imperfection and complexity affect this order of the capital structure in addition to the yield differentials among these asset classes? For example, some assume that equity finance has a higher risk than debt finance and that risk adjusted differentials are not equated. Does your hypothesis determine who sets the issue terms, the quantity of the security issue and how much is purchased by financial investors and intermediaries?
      4. When you say “overlapping model” are you refering to a model with a generation survival rate of owners(households) as in Blanchard (1985)? Is the survival rate (i.i.d) as usually assumed in these models to assure stationarity?
      5. The averaging out of equity rates to the growth rate is some long term steady state rate? Are you using some adaptive exponential smoothing factor term that decays as time gets very large?

      If the discussion procceeds I can undestand more and maybe I have some constructive suggestions, assuming you want them.

    41. P,

      That’s a lot of questions! First, there is the issue trying to make simple models, and then there is the issue of interpreting the real world. What’s most interesting to me know is making simple models, with the smallest possible set of assumptions that can explain the stylized facts that we see. This means no tax distortions and other effects that you describe.

      I think one problem with heterodox economists was that they looked at the models, didn’t like the effects that they saw, and just assumed that the reason reality differed so dramatically from the model was that the models didn’t incorporate enough complexity. I don’t think this is the case. I think the micro-foundations are wrong. If you fix them, you can still get the basic effects that are observed. And I am trying to do this with the simplest set of assumptions possible.

      When talking about actual markets and prices, it becomes a bit hopeless since no effect will be able to generate a model that either correctly predicts asset values nor a model that correctly predicts their variance — which may well be infinite. We have no idea what the actual distribution of returns is. As soon as you assume what it is, then you are already working in a highly stylized context, and adding additional baroque details may or may not make the model “better” — it may just make it more complicated.

      In terms of funding priorities, I’m assuming that there is an initial endowment of funds raised by selling equity. If you assume that the average (financial) returns are a concave function starting at 0 when the capital stock is small, and with a unique maximum, then you can show (e.g. prove) that optimal equity investment is when the average return hits the consol rate for the first time. So all firms would start with the capital stock at this level.

      Thereafter, the firm is free to capitalize itself with any combination of bonds or retained earnings. The condition that the choice of one or the other will not affect the enterprise value generates the arbitrage free rates for bonds for that firm. You can then take the expected value for all firms to get the average market rate. Again, all of this is an attempt to show that yields are driven by the characteristics of production and growth in the real economy, rather than an argument (as many PK models have) that yields are exogenous. Of course yields are subject to manipulation, but to the degree that they deviate from the endogenous, or natural yields — this just means that someone is earning economic rents. Rather than trying to “set” interest rates we should be very careful that our policies do not cause interest rates to deviate from their arbtrage-free levels. In the ideal case, welfare is enhanced when the government interacts with the real economy via fiscal policy, and CB-backed banks are prevented from either buying or selling debt, but are only allowed to sell equity and issue mortgage and small business loans according to government supplied standards.

      In terms of overlapping generations, I’m not using the discreet model here, but assuming as per Romer that there is some form of invention model. In my case, a simple invention model would be a random variable taking values in the concave return functions. From this you get a consol rate. Then you start with some distribution of firms, and can determine how many new forms of capital are created rather than adding to the existing forms. So the invention model is the oracle, and you are creating a flow of new forms of capital while also increasing the flow of the existing forms of capital. The arbitrage-free condition can then be used to determine — in the ideal case — how much of investment is directed at existing firms and how often you call the oracle. P/E ratios should neither rise nor fall, but if you make no calls to the oracle, then they will fall whereas if you only make calls to the oracle, then they will rise. There is a unique steady state in terms of flows here, and this state will determine the growth rate of the capital stock. Then you can see how a change in the distribution, e.g. due to a stochastic shock, will trigger a change in investment rates.

      Again, these are very simple models, but the point is to see how far you can get with the simplest set of assumptions. Then you can add more and more baroque features on top of that — asset bubbles and financial panics, etc — assuming you have a solid base.

      But the simple point here, whether you agree with any particular model or not — is that returns — at all maturities — are determined by the assumption that the model is arbitrage-free together with the characteristics of capital growth. Any deviation between the arbitrage-free rates and the actual rates necessarily supplies economic rents. The most fair policy is to minimize these economic rents — i.e. to let all credit market rates float, by preventing banks with access to the discount window from participating in these markets. If you put enough of a wall around banks and the credit markets, preventing them from issuing paper or any liability other than equity, and prevent them from holding any assets other than public purpose lending, with special taxes levied on banks and dividend restrictions, then you can set the marginal cost of reserves to be whatever you want and the credit market rates will continue to float.

      What we have now is arbitrage, with enormous economic rents being funneled into the financial sector, as the banks have lower funding costs than productive enterprises, and they use the lower costs to evade regulation and buy up assets.

    42. Anon

      “What are the arguments for rentiers …”

      Rentiers are savers.

      What are the arguments for punishing savers?

      Why should savers who outsource their investing be punished for it?

      Do you have to own a steel mill in order to save without being punished for it?”

      Why should someone who forgoes consumption today (presumably because the dont need to consume) be guaranteed the ability to consume the same level in the future? Saving is great, consuming only what you need is great (reduces waste) but I have come to the view that savers should not expect nor should they complain loudly if they are unable to consume the same level of stuff at the later date they choose. Its not savers who should run the economy any more than consumers.

      I find it interesting how inflation is often referred to as a form of default or punishment to savers. Does this make deflation a form of usury and an excessive reward to savers? All the inflation fears we’ve had have placed a deflationary bias to our economy. All this does is further hurt people with private debt and increase risks of default.

    43. Well, Greg, historically the bias has been towards inflation, and not deflation.

      But that bias is primarily due to credit growth. It is credit growth that forces the hard powered money to grow. But you are right, the only way to “save” is to dig a hole in the ground, put all the food and clothing you want to consume later into the hole, and then dig it up when you retire.

      Of course, you need to post guards around the hole, pay them, and also rent the hole. And you will find that the goods put into the hole deteriorate with time.

      The only way to get a return is to invest. If you invest, you will get a positive return in a growing economy, but that same mechanism will create inflation that will eat away some of that return. In the end the savers expect magic — they want a credit-based economy that allows them to invest, but they don’t want the inflation generated by credit-growth. They are not happy with the real rate of return, which is positive, at say 3%, but is volatile. They demand the nominal rate of return, or 6%, without the volatility. To them, anything less than the nominal return is robbery, when they should be happy for the real rate of return. That is much better then the alternative, which is to start digging.

    44. Anon,

      It don’t see it as an agenda. It seems to me that the shifts in the distribution of income throughout the last 30-40 years has been very high. The recent decade has shown that. My view is that this decade it will be accelerated. For example, Bill pointed out in one comment that the oil sellers will greatly threaten the growth of world economies. The distribution is going in an unsustainable path.

      The way the monetary system works, it is not difficult to achieve win-win-win situations.

    45. RSJ,

      1. Regarding assumptions. Assumptions must be realistic and conform to what is observed and not as Freidman (by the way, a teacher of mine) test a model with simplistic assumptions based on statistical evidence. A model must be based on the dialectical method where the assumptions interact with logic to lead to a hypothesis. You incorporate imperfection and the resulting complexity not as an add on but as primary essentials of any analysis. Otherwise it is only a “toy model” as described yours. Ideal circumstances are not reality.
      2. Not all PK models incorporate the interest rate as arbitrary. For example, the “fair rate” estimation is based on real productivity growth. See my next comment on the risk free interest rate for references.
      3. Let us talk arbitrage because you base your analysis on it. Is arbitrage costless and “naked”? If yes, bank market power is not the only source for a rent premium. Arbitrage and collateral cost adjustment must be included in rate differentials. Floating credit rates will not eliminate the rent differentials not even deal with the market power of finacial intermediaries.
      4. You do not have any answer to the order of finance and you do not even incorporate any financial layering or even a Minsky based differentiation of the types of finance that can lead to finacial instability. There are differences that must be incorporated as debt benefits from interest payment tax deductions and other trade offs imposed by imperfection and complexity as the ‘Pecking Order” approach. Instead you are refering to an ALL EQUITY finance which is not what we obseve. Notice that the structure of finance is critical for the capital structure and real economic activity and growth.
      5. You are using the random/stochastic model of invention (Romer) of capital formation. Where is pure uncertainty, convention, “animal spirits” and beliefs in your analysis? You do not mention them. Where are “random jumps” which are important in invention and they lead to a Power Law specification of the model and can bring instability.
      6. What is your model specification for the adjustment to the LT growth term? In my previous comment I asked if you are using an adaptive exponential smoothing strategy. I assume you are using an instaneous adgustment based on rational expectations.

      I hope my comments help you in your efforts.


      1. A risk-free rate or the term of a rate for a security that if held it imposes no risk of price/exchange variation or default and is completely and without cost acceptable as a means of payment.

      2. A risk-free rate CAN include a term for time preference. Assuming time preference for holding securities implies that there is a preference for immediate rather than delayed spending (Assuming transversality). Thus the longer the holding period (duration/maturity) of a security, the higher the time preference discount factor. Alternatively, a security with nearly immediate repayment on demand has a time preference discount that converges asymptotically to zero.

      3. A risk-free rate CAN include a term for growth as a security is an equivalent to a deffered command over resources whose productivity during the delay period corresponds to the compensation for holding the security. Again, a very ST security has a very miniscule growth term compensation corresponding to the miniscule productivity performed during the very ST and this term converges asymptotically to zero. This is equivalent to the “fair rate” estimation, see Lavoie, Seccareccia (1999).

      4. NOTICE that the very ST which is also near free-risk rate such as the Federal Funds rate, CAN approximate a “natural” rate of zero. See Mosler, Forsteter (2004) and Atesoglu, Smithin (2006). This implies, as per previous points, that the rate incorporates NO RISK, NO TIME DISCOUNT AND NO PRODUCTIVITY COMMAND during this nearly immediate time period.



      I have excluded the inflationary expectations term from the analysis as I deal in nominal rates and any inflationary risk I include in the risk category. Obviosly, also the growth rate here is a nominal value.

    48. Ramanan,

      The annual US gov deficit interest cost is about $ 300 billion.

      That disappears under zero bonds and zero rates.

      And as I think you subscribe to the full yield curve effect vis a vis the risk free rate, a corresponding number of some sort gets subtracted from risky bond yields.

      All these fixed income instruments are held by households, pension funds, insurance companies, mutual funds, etc. etc.

      That to me is an agenda.

    49. RSJ

      “Well, Greg, historically the bias has been towards inflation, and not deflation.

      But that bias is primarily due to credit growth. It is credit growth that forces the hard powered money to grow. But you are right, the only way to “save” is to dig a hole in the ground, put all the food and clothing you want to consume later into the hole, and then dig it up when you retire.

      Of course, you need to post guards around the hole, pay them, and also rent the hole. And you will find that the goods put into the hole deteriorate with time.

      The only way to get a return is to invest. If you invest, you will get a positive return in a growing economy, but that same mechanism will create inflation that will eat away some of that return. In the end the savers expect magic — they want a credit-based economy that allows them to invest, but they don’t want the inflation generated by credit-growth. They are not happy with the real rate of return, which is positive, at say 3%, but is volatile. They demand the nominal rate of return, or 6%, without the volatility. To them, anything less than the nominal return is robbery, when they should be happy for the real rate of return. That is much better then the alternative, which is to start digging.”

      Thanks for the response and I couldnt agree more. Saving is good, hoarding (which is what too many savers end up doing) is bad.

      The deflationary bias I was referring to is at present. Which of course is exactly when a deflationary bias is destructive (and not creatively so). The low lows end up destroying everything gained (nominally) from the high highs.

    50. Anon: That to me is an agenda.”

      I see the agenda as giving 300 billion away as a needless subsidy that is a dead weight better used. Bond issuance is unnecessary under a fiat system, and interest rate setting by a small unelected group that is not accountable is undemocratic and anti-capitalistic.

      It seems to me that the agenda here is solely redistribution.

    51. RSJ – The Google Books link of the article you were talking of @ Wednesday, June 16, 2010 at 6:57 is:

      Long Term Interest Rates, Liquidity Preference And Limits Of Central Banking by Mario Seccareccia and Marc Lavoie.

      Quoting a few lines from pages 167, 168:

      In more recent times, however, there are also some heterodox economists who have come to espouse a variant of this approach, which sees the rate or profit as a determining factor behind the long-term rate or interest. Authors such as Wray (1991,1992) express this by saying that the price of short- term bonds relative to that or long-term bonds is an inverse function of the relative proportions in which the public desires them. Therefore, once the monetary authorities determine the returns on the short end of the bond market, market forces would inevitably govern long-term yields via portfolio choice.

      In recent years. Nell (1998, 1999) has further articulated this view. In a nutshell, it is believed that when the rate of growth of the economy is high, so is the rate of profit, in accordance with the well-known Cambridge equation, and hence so will be the long-term rate of interest. Since stock market returns closely follow the vagaries of the profit rates of firms, ultimately the rates of return on the stock market would play a critical role in determining long-term rates of interest. To understand this, let us imagine a state in which the rate or growth of the economy (and therefore, via the Cambridge equation, the rate of profit) exceeds the long-term rate of interest. Since real assets will be compounding faster than financial assets of long-term bondholders, asset owners will be shifting about their Portfolio in favour or holding stocks and away from bonds (Nell, 1999, p. 286). Through the process or capital arbitrage, therefore, prices or long-term bonds would fall, interest rates would rise, which would bring about a gradual restructuring of the yield curve in favour of higher long-term yields. Conversely, in a state in which the rate of growth (and rate of profit) is below the current long-term yield, there would be a movement away from real assets and towards financial holdings. As a result prices of long-term securities would rise and long-term interest rates would fall. Once again. through a process of capital arbitrage, movements in the economy-wide rate of profit (as reflected in variations in the economy’s rate of growth) would ultimately bring about a concomitant movement in long-term interest rates. In this case, much like previous Wicksellian analytics, the governing rate or center of gravitation is the rate of profit or rate of return on stocks while the long-term rate of interest would follow with a lag the movement of the rate of profit through capital arbitrage.

      Unfortunately I cant view all the pages on Google Books :(

    52. Ramanan,

      One point of clarification regarding the main issue (about the CB control of ST rates) of the article you quote above. In case there is confusion,its results do not prove that CB policy on the ST rate can control the LT rate. Certainly it can influence it but not control it. Even the Granger causality tests do not violate this position.

    53. RSJ,

      Here is another Google books link: Transformational Growth, Interest Rates and the Golden Rule by Marc Lavoie, Gabriel Rodriguez and Mario Seccareccia. Google books allows viewing all pages (-:


      While I actually do not believe that the long term rate is some expected short term rates, I believe that it does not control the government bond yields, though the central bank may do that in some not-so-limited ways by maturity composition. When I make statements such as it can be made exogenous, I mean it can be made by brute force – only for government bonds, but thats a slightly different topic. Of course, I do not really believe in the “expected central bank reaction function” theory because the central bank doesn’t know its future path either – one can’t predict the future.

    54. Ramanan,

      I am in sympathy of the distributional view of interest rates as some of the PK paradigm. However, Moore has a point when we consider the reality of what the CB does even if not successful if we want to analyse MP.


      In my work I have developed the hypothesis that the growth rate of GDP has a dynamic feedback effect upon the risk component of LT rates and in particular it reduces the expected shortfall given default of LT securities. Actually, sometime ago I presented a simplified equation in a comment in Billyblog. In summary, this is the product of duration, the probability of default and a shortfall feedback equation adgusted by the change in the growth rate. The probability of default is calibrated to incorporate terms such as a mean rate subject to a Poisson process, a Brownian motion random step function as an exponential process and a random jump term as an asymptotic hyperbolic function subject to a Pareto process. Thus growth can influence negatively even the risk premium component of LT rates, especially the tail end of this risk, maintaining or even rising any spread between the two. Actually, it can also shift the slope of the yield curve.

    56. P — to the degree that one models returns, or human behavior, with mathematic functions, then they are working with toy models. The goal is not to have “realistic” assumptions, but plausible ones. The fewer assumptions the better, actually. I can address some of the other issues you raised at a later time.

      R — yes, that’s the paper. They apply an HP filter to test golden rule growth rates, IIRC. You cannot claim that the government can control the market price of government bonds but not all other assets. All assets compete and are priced at an indifference level.

      T — the interest income on government bond yields does not increase household net financial assets. The fallacy here is assuming that private sector NFA are the same as household sector NFA. Interest payments on government debt adds/subtracts to the NFA of households only to the degree that the bonds were mispriced. They may be mispriced, but there is no reason to believe that they are consistently undervalued.

      What adds to the household NFA is the increase in demand due to deficit spending. The NPV of these demand boosts increase household net financial assets, regardless of whether that deficit spending is funded by the creation of currency or the creation of bonds.

    57. Scott Fullwiler says:
      Now you’re the one who’s misunderstood. The desire to expand nets to zero in terms of assets and liabilities on the non-govt sector’s balance sheet. The non-govt sector’s desire to net save shows up as a deficit for the govt sector. This is the difference between horizontal and vertical money. Consequently, the desire to “expand” doesn’t necessarily mean that you haven’t net saved.
      But neither does it necessarily mean you have net saved. As I said, it’s a contingency not a condition.

      As for the horizontal v vertical money argument, there is no reason why the money has to be entirely horizontal. There’s a mechanism for a vertical component and it is well used.

      Historically, aside from the 1998-2008 period, which is a clear aberration that is now resulting in the “balance sheet recession” (though the seeds of that period were being sown for a few decades) the non-govt sector in the US had virtually always net saved (aside from a few . Note that this does not mean they don’t expand their balance sheets as you’ve said, but that’s an expansion of the horizontal component of money (and to be more specific, within the non-govt sector, the firm sector does procyclically move between net deficits (expansion, as you note) and net saving during recessions, whereas the household sector would always be net saving prior to 1998).
      And as house prices continue to rise, the 1998-2008 situation is likely to become more prevalent.

      Regarding Japan’s yen collapsing with public sector deficits and no external surplus, hasn’t yet happened in the US. Your analysis there is far too simplistic.
      It won’t happen to the US while Dollar hegemony continues. And with the Euro in trouble and the Khaleeji’s implementation delayed several years, America’s currency remains relatively secure. Look at what’s happened to the Pound for a more typical situation.

      Go see Warren’s new video on his site on the fundamentals vs. technicals for fx.

      You clearly don’t understand much MMT even as you attempt to critique it (or me)
      What I try to understand is the situation. MMT often helps, but I don’t assume it to always be correct.

    58. RSJ,

      I have indicated in my previous comments on imperfection and complexity and there is also a lot of math behind this that simplified and non realistic assumptions lead to erroneous analysis. One has to be careful with the assumptions he makes and the logic he uses. Wait for my next comment on relativity and bifurcation to see how possible is to shift from an equilibrium to multiple ones and instability. So be careful with “toy” models they can be hazardous to your health.

    59. I agree that you need to be careful with toy models, P, but every model you espoused is equally a toy model. Any model that tries to capture human behavior with mathematical equations falls into this category. Nevertheless, we press on, because we do observe patterns, constraints, and we need some basis on which to make policy recommendations other than partial equilibrium reasoning. And there is nothing wrong with building on the features of models to incorporate additional effects — but you need to persuasively argue that the added complications reverse or significantly alter the conclusions of the model in a meaningful way — not that they just add complexity. It is not enough to argue that you can derive some complicated effect with more complicated assumptions. You need to argue that the same effect cannot be captured with simpler assumptions, and that the effect actually occurs as predicted. Even then, the odds that your assumptions are really necessary to capture the gross movements that we see are unlikely — that’s a very high bar that you need to pass, P, because the economy is filled with noise that wont be captured by any model.

      In regards to order of financing — for legal, logical, and operational reasons, equity must preceed bond financing. When a firm sells bonds, the money comes out of a reduction in equity — the firm is shifting its capital structure. Each individual can of course borrow to purchase equity from someone else, but from the point of view of the firm, it is financed with equity first. There must be an owner who can agree to assume the debt obligation. I think the existing models go wrong in just talking of “bonds” in their models — if you have only one instrument, then it must be equity. If you have two, the second can be a bond, but again the enterprise value will be unchanged when the firm sells bonds.

      If the standard econ models took account of this, they would not have a transversality condition in which the net present value of financial assets goes to zero, because the enterprise value will not go to zero — it will grow with the size of the capital stock, and will always be greater than the size of the capital stock.

      Of course, in the real world, the majority of capital has no access to the bond markets, and only the top 100 or so firms account for the vast majority of all non-financial domestic bond issuance in the U.S. — and we have the deepest bond markets in the world. Nevertheless, only large, mature firms with proven cash-flows can access these markets. Prior to that access, they are funded with equity. I think 80% of U.S. non-financial corporate investment is funded with equity, and pretty much all of non-corporate investment is as well. Once you start talking about the rest of the world, the bond markets get very thin very fast.

    Leave a Reply

    Your email address will not be published. Required fields are marked *

    This site uses Akismet to reduce spam. Learn how your comment data is processed.

    Back To Top