Sorry for my ignorance,
I am trying to understand economics better for discussion. Could someone help me to understand.
Why don't low interest rates create new capital?
Thank You.
In slightly over-simplified language:
High interest rates: Savers can earn greater rewards from saving, so they save more. Businesses have to pay more for loaned funds, so they borrow less.
Low interest rates: Savers can't earn as much from saving, so they save less. Businesses can get cheaper loans, so they borrow more.
Artificially low interest rates as a result of Fed stimulation cause savers to save less - there is less accumulation of real savings (deferred consumption) when this is precisely what the economy needs, an increase in real savings and a decrease in consumption and business investment. Such a state of affairs can be called "painful" but it is really most painful for the super-wealthy who are running the system, for those consumers who borrowed and/or spent too much and and for those businesses that over-expanded. The rest of us (the 99%, to borrow the new buzz-phrase) would be alright and, once the market cleared in a matter of a few quarters, everyone could return to business-as-usual on a solid foundation of market interest rates and, hopefully, sound money.
Note that Paul Volcker did exactly this (allowed interest rates to rise to market-clearing levels) in the early 1980's and the Austrians argue that Volcker's actions laid the foundation for the spectacular growth seen in many industries throughout the 1980's.
Clayton -
It depends, which terminology you are using.
In Austrian terms, capital is not money, capital is the specific goods (like machines, factories, raw materials) which are created not for the sake of their consumption, but in order to produce other goods.
It is obvious that low interest rates cannot (directly) create factories. If your phrasing is understood broadly, then lower interest rates may make more investment in production of capital goods profitable - but only ceteris paribus - all other things being equal. When lower interest rates are a natural result of lower time preference among people, then this increased investment may very well indeed happen. When the government (using the Fed) keeps the rates artificially low, that's another story. This affects so many other things, that increased investment is far from being likely.
Hope that I understood your question correctly, otherwise don't hesitate to clarify.
And welcome to the forum!
Thank you Andris,
Sorry for my vagueness, to define my question more thoroughly. I am referring to Ron Paul's explanation of the form of the bubble. He said that Alan Greenspan was most likely aware of the imminent recession so he kept interest rates at an historic low to prolong the bubble. Ron briefly added that artificially low interest rates don't generate capital. Then he went on to his conclusion.
So while pondering this, I wanted a better understanding of how interest rates affect capital. I understand that I lack basic economic knowledge but I’d really like to learn as it interests me.
You answer, along with any suggested reading you might offer, would be greatly appreciated.
Thanks Again,
Dan
I would need a direct quote or video of Ron Paul's explanation to respond to his argument.
Low interest rates give businesses an incentive to buy more capital. However, Alan Greenspan lowered interest rates below the market rate of interest. This caused more borrowing. With more borrowers, there was more investment...but it was malinvestment. Businesses invested in capital (land, labor, machines, factories) that were profitable at the time. However, some companies misjudged profit and some consumers changed buying preferences. When these profit misjudgements happen and consumers changed prdeferences on a large scale, we have a recession. Because of artificially low interest rates, these misjudgements were magnified. i.e. People were able to buy more expensive houses that they could not afford and banks were able to make larger deals and businesses were able to make bigger investments. In the short term, we gain more. But when recession hits, we lose more.
Google Man, Economy, State. Find the PDF. Use the find feature in the PDF, search "interest rates and capital" or something similar.
will do, and thank you for your response
It's a false indicator, the real savings aren't really there.
Ahhh, that clears it up a bit.
This also adds further clarification to another thing I've been wondering about regarding the motives of people like Greenspan who continued bad policy knowingly.
"Such a state of affairs can be called "painful" but it is really most painful for the super-wealthy who are running the system, for those consumers who borrowed and/or spent too much and and for those businesses that over-expanded."