Economics Questions

Re: Interest rate: deflation, inflation

z1235 — Wed, 24 Mar 2010 14:29:30 GMT

As I said in the first sentence of the first reply in this thread:

"You can demand any rate (and at any risk level) you want but there's no guarantee that the market will give it to you."

The argument that the rate of return on your loan MUST be higher than your inflation estimate over the life of the loan is the same as saying that the price for the shares in your company that you are selling MUST be higher than your earnings or discounted cash flow estimates. In either case, you'll get whatever the market will pay for what you're selling and not a penny more. There are no guarantees or floors on prices in a free market.

Re: Interest rate: deflation, inflation

Nielsio — Wed, 24 Mar 2010 07:01:04 GMT

Robert Murphy helps out:

--
I see what you're saying, and yes it seems there is some tension between the treatment of the two cases. I guess you're right that in principle someone would be willing to lend at 5% even if price inflation were 10%, because that's better than sitting on your money and earning a nominal 0%.

It's an interesting point I've never really thought about it. Economists (not just Hoppe) routinely say that investors insist on a real return, which means getting at least the rate of inflation. I guess if you already believe in time preference, then the result pops out, but you're right it's not a separate argument for it.
--

Re: Interest rate: deflation, inflation

filc — Tue, 23 Mar 2010 23:46:50 GMT

Nielsio:
expected inflation (deflation) reduces (increases) the demand for money

1. Expected inflation reduces the demand for money

This is the demand for money(Cash). People have no desire to hold onto money(cash) and instead people prefer to:

A) Spend their money NOW and get tangible goods while their purchasing power remains in tact

In other words expected inflation drives the motive for heavily consumer based economy supporting things like retail. People prefer to consume NOW rather then later as they realize their purchasing power is shrinking.

B) Through their money in a high risk high gain/loss investment vehicle

Since less people are saving this dwindles the money stock, naturally raising the price for credit. (Supply and demand). When interest rates rise naturally it deters borrows from borrowing while the cash saving stock slowly starts to grow.

2. Expected deflation increases the demand for money.

A) Save their cash now and buy tangible goods later as their purchasing power increases over time

People prefer to consume later rather then now as they know their purchasing power will be greater, it is growing.

B) Savings in straight cash allowing the outright purchase of higher order goods, or slower but higher secured investment vehicles

Since more people are savings, the money stock goes up. The demand for credit becomes low because there is so much savings. As a result interest rates drop due to growing reserves and an attempt to attract customers

Thats how I gather it.

Re: Interest rate: deflation, inflation

onebornfree — Tue, 23 Mar 2010 23:42:48 GMT

Nielsio:

I emailed Hans Hoppe my question and this is what he replied:

"[..], expected inflation (deflation) reduces (increases) the demand for money and brings on the expected event: inflation (deflation) immediately to yield a positive interest rate in every case."

Can anyone figure out what that means exactly?

He appears to be saying that regardless of demand for money increases or decreases on the supply, due to general expectations for the future, that a positive interest rate is always inevitable.

In other words, regardless of increase or decreased demand for money,[perhaps in relation to an assumed steady supply?], a zero, or negative interest rate is an impossibility.

Maybe

Regards, onebornfree.

Re: Interest rate: deflation, inflation

Nielsio — Tue, 23 Mar 2010 23:16:22 GMT

I emailed Hans Hoppe my question and this is what he replied:

"[..], expected inflation (deflation) reduces (increases) the demand for money and brings on the expected event: inflation (deflation) immediately to yield a positive interest rate in every case."

Can anyone figure out what that means exactly?

Re: Interest rate: deflation, inflation

Nielsio — Tue, 23 Mar 2010 15:05:29 GMT

LibertarianfromGermany:

Am I the only one thinking that the reason the interest rate tends to stay above the inflation rate is because if it didn't (ie lending out would equal a loss in purchasing power) potential borrowers would just switch to commodities (i.e. gold) to at least retain most of their purchasing power? Of course governments can try (and often will) counter this to a certain point with taxes on commodities, but the point stays that if the inflation rate is continually higher than the interest rate, switching to gold would in the long run pay off even with a high tax for the initial purchase. I mean - this is basically why so many Austrians are currently investing in PMs.

If the source of inflation is government printing, then they generally tax you for capital gains (including on gold). So at least legally, that's not a complete answer to the question. Also, loaning sub-inflation would still benefit them. And if your answer is what Hoppe means then I would have expected him to bring it up. He didn't, and it looks to me like he's only comparing it to not-lending.

If the source of inflation is gold mining under a real gold standard, then your solution doesn't exist unless people switch to a different commodity. Would there always be a different commodity that people could switch to? Including if we take into account the effects of all most people switching? Seems rather radical, and also not really what Hoppe would have in mind here.

Re: Interest rate: deflation, inflation

onebornfree — Tue, 23 Mar 2010 14:37:24 GMT

LibertarianfromGermany:

Am I the only one thinking that the reason the interest rate tends to stay above the inflation rate is because if it didn't (ie lending out would equal a loss in purchasing power) potential borrowers would just switch to commodities (i.e. gold) to at least retain most of their purchasing power?

No, and you are correct- I believe.

For example, in around 1981-2, at the peak of the last severe bout of inflation[ roughly mid 70's through '81--2], interest rates on US treasuries climbed over 15%.

Meanwhile, gold peaked at around $800 per oz., and stocks "languished" so to speak.

Of course, lacking predictive capabilities, many gold bugs refused to sell at that '81 peak price , thinking the price would go higher still,[when it did not], and many other persons [again lacking those mythical predictive powers] refused to buy stocks [when the at this point ravaged stock market was preparing to go on a 20+ year joy ride!], or to consider buying US treasuries, which were [given the existing inflationary environment at the time] widely viewed as a way of guaranteeing future loss of purchasing power, it being assumed by many that the super-inflationary environment [comparitively speaking] of those years was bound to continue. Boy, were they wrong.

As they say: "hindsight is 20-20"

P.S. in a rare instance of prescience I am still unjustly proud of, I issued a "buy" signal to clients for gold in the mid '90's , when it was down around $250 per oz.

The truth is, I'm NOT prescient- I just got lucky that one time.

Regards, onebornfree

Re: Interest rate: deflation, inflation

LibertarianfromGermany — Tue, 23 Mar 2010 08:26:43 GMT

Am I the only one thinking that the reason the interest rate tends to stay above the inflation rate is because if it didn't (ie lending out would equal a loss in purchasing power) potential borrowers would just switch to commodities (i.e. gold) to at least retain most of their purchasing power? Of course governments can try (and often will) counter this to a certain point with taxes on commodities, but the point stays that if the inflation rate is continually higher than the interest rate, switching to gold would in the long run pay off even with a high tax for the initial purchase. I mean - this is basically why so many Austrians are currently investing in PMs.

Re: Interest rate: deflation, inflation

filc — Tue, 23 Mar 2010 06:34:48 GMT

DD5:
There is nothing special about a bank loan

Oh I agree. Investment is investment.

Re: Interest rate: deflation, inflation

DD5 — Tue, 23 Mar 2010 05:32:40 GMT

filc:
Hmmm I maintain that even when used as an example an ERE is a dangerous tool. It's very premise is paradoxical.

"Recourse to the imaginary construction of an evenly rotating economy is, as has been pointed out,[1] an indispensable mental tool of economic reasoning." (Mises, Ch 26,2 , Human Action)

filc:
The only way an ERE would make any kind of sense is if we replaced humans with pre-programed repetitive robots.

Nobody is denying this.

Mises continues:

"But it is a grave mistake to consider this auxiliary tool as anything else than an imaginary construction, and to overlook the fact that it has not only no counterpart in reality, but [p. 702] cannot even be thought through consistently to its ultimate logical consequences."

filc:
By and large I think the points Nielso is raising, whether or not they pertain to Hoppe's speach, are wholly relevant and worth considering.

There is nothing special about a bank loan with regards to the question of whether as part of the interest rate, inflation is covered for or not.

Re: Interest rate: deflation, inflation

Nielsio — Tue, 23 Mar 2010 05:32:01 GMT

filc:

Investment behavior under inflation, as Nielso points out, necessarily leads to risky behavior, and only supports the boom portion of the business cycle.

Well, I'm not necessarily saying that's true. But that would appear a result on what Hoppe is saying; if he thinks only inflation-beating loans would be extended.

Re: Interest rate: deflation, inflation

Nielsio — Tue, 23 Mar 2010 05:29:35 GMT

DD5:

Nielsio:
But those are higher risk, and who says I want to take that risk? Maybe I only want low risk, even if that doesn't cover inflation.

There is no risk in the ERE. There is no uncertainty.

Nielsio:
Hoppe seems to dismiss that option out of hand

No he's not. He simplifies the analysis by referring to the hypotheical ERE. The problems you raise regarding risk, or more appropriately, uncertainty, are present in every type of investment. There is nothing special about a bank loan.

Nielsio:
Personally, I don't beat inflation with my current interest rate.

There were times of low inflation and high interest rates where people, in retrospect, certainly managed to beat inflation

Nielsio:
That doesn't mean I'm going to gamble all my savings in the stock market.

You mentally factor that in with your monetary income from interest. There is a psychic component to your income that is not monetary. Monetary income (or costs) is itself just a sub-component of the total psychic income. Good Austrians never forget the psychic component of economic analysis.

Since the pure psychic component is not subject to monetary calculations, It is simply dropped out for simplicity. It is also assumed that the monetary component is often the main component anyway.

I don't see how any of this addresses my questions and my points. All I'm seeing are non-sequitors. Now, maybe I'm dumb. But this isn't helping me.

1. Hoppe doesn't bring up ERE, whatever that may mean. This means that this shouldn't have to be included for his explanation to work.

2. Yes, people may have beaten inflation with low-risk savings. So what? What does that have to do with the fact that currently I am not keeping my savings under my mattress and not investing with higher risk for higher reward? I am asking specifically how that doesn't invalidate his claim, and then you bring up some other situation. ???. Maybe I'm misunderstanding his claim. If that's the case please explain it in words that anyone can understand.

3. 'Good Austrians never forget the psychic component of economic analysis'. So what? What does that have to do with what I'm saying?

Re: Interest rate: deflation, inflation

filc — Tue, 23 Mar 2010 05:24:08 GMT

Hmmm I maintain that even when used as an example an ERE is a dangerous tool. It's very premise is paradoxical.

If there is no uncertainty, there is no action, there is no economy. An ERE assumes action takes place, which assumes uncertainty.

The only way an ERE would make any kind of sense is if we replaced humans with pre-programed repetitive robots.

By and large I think the points Nielso is raising, whether or not they pertain to Hoppe's speech, are wholly relevant and worth considering.

Investment behavior under inflation, as Nielso points out, necessarily leads to risky behavior, and only supports the boom portion of the business cycle.

Re: Interest rate: deflation, inflation

DD5 — Tue, 23 Mar 2010 05:05:27 GMT

Nielsio:
But those are higher risk, and who says I want to take that risk? Maybe I only want low risk, even if that doesn't cover inflation.

There is no risk in the ERE. There is no uncertainty.

Nielsio:
Hoppe seems to dismiss that option out of hand

No he's not. He simplifies the analysis by referring to the hypotheical ERE. The problems you raise regarding risk, or more appropriately, uncertainty, are present in every type of investment. There is nothing special about a bank loan.

Nielsio:
Personally, I don't beat inflation with my current interest rate.

There were times of low inflation and high interest rates where people, in retrospect, certainly managed to beat inflation

Nielsio:
That doesn't mean I'm going to gamble all my savings in the stock market.

You mentally factor that in with your monetary income from interest. There is a psychic component to your income that is not monetary. Monetary income (or costs) is itself just a sub-component of the total psychic income. Good Austrians never forget the psychic component of economic analysis.

Since the pure psychic component is not subject to monetary calculations, It is simply dropped out for simplicity. It is also assumed that the monetary component is often the main component anyway.

Re: Interest rate: deflation, inflation

Nielsio — Tue, 23 Mar 2010 04:52:31 GMT

DD5:

Nielsio:
Now, under inflation, don't we also have to compare loaning out money with sitting on it? Because if we sit on it it will lose value. So wouldn't getting more monetary units back in a year be better, even if we can't beat inflation?

Yes but there are many more alternatives then just the 2 options you mentioned. You can invest in stocks, commodities, real-estate, etc..

The interest rate is the price of future goods in terms of present goods for all types of investment, and not just for the loans market.

But those are higher risk, and who says I want to take that risk? Maybe I only want low risk, even if that doesn't cover inflation. Hoppe seems to dismiss that option out of hand. Personally, I don't beat inflation with my current interest rate. That doesn't mean I'm going to gamble all my savings in the stock market. BUT I am still going to decide to keep my money in a savings account (and the rest of society with me). How does that not invalidate what he's saying?