Chapter 3: In which Mr. Rowe proves his worth
Did you know that we live in a fantasy world where we can get stuff for free? I didn’t either. But apparently, we do. There is a free lunch.
I turn it over to Mr. Rowe.
“There is something economists have known since 1958 that we don’t talk about much, except in private, like in economics journals that nobody else reads. It’s a bit too weird.
There are two sorts of world. In a normal world, the equilibrium rate of interest is above the growth rate of the economy. In a weird world, the equilibrium rate of interest is below the growth rate of the economy. What’s weird about a weird world is that it needs a bubble, a Ponzi scheme, a chain-letter swindle, for the economy to work well.
Maybe the world we live in is a weird world. And it needs a bubble to work well. And the economy keeps trying to create a bubble. And when it succeeds the economy does work well. But bubbles are unstable and eventually burst. Then it works badly again. Until the next bubble.
Ok – stop right there, Mr. Rowe. You’re telling me if the real rate of interest, r, is less then the real growth rate, g, then we live in a fantasy bubble world where we get stuff for free? That happens all the time! In fact, the last 20 years have been like that! What does this mean?
“Governments can create the bubble, with a national debt they never pay the interest on, but just rollover from one year to the next. A Ponzi scheme. If spending and tax revenues grow at the growth rate of the economy, and that growth rate is above the rate of interest, they can do this forever. The long run government budget constraint just doesn’t add up, literally.
Come on! We don’t live in a world like that! It goes against what we see in…wait. This is exactly what we see in the real world. The budget constraint does not add up, just like Scott Fullwiler says, and it does not matter anyway! We veer from Bubble to Bubble, first stocks, then real estate, now commodities and emerging markets like China. Why? The economy demands it when g is greater than r.
We want our free lunch! We want our free lunch!
It is really a demand for a free lunch. He draws this neat picture to show what he means more clearly:
As long as the real growth rate is higher than the real interest rate, the economy will demand bubbles. If they are not accomidated, the economy will find something to make into a bubble. It does this through using things that are not money as money. Like stocks being used to purchase real world goods, or using the paper value of real estate as collateral to purchase real world goods.
This is not very controversial in on main street USA. We see people going nuts to borrow money so they can satisfy this demand for a bubble. If the government just supplied the money to close this gap a bit, the public would not be constantly trying to blow bubbles.
There is much much more to this model that Nick doesn’t talk about. For example, what happens when g is less than r? instead of drawing that line above the equilibrium point, draw it below. Anti-bubble time. The economy searches out and destroys leverage. Think Japan, where the real rate of return has been relatively high, but low growth.
Also, since r and g are kinda sorta related to inflation, the zero bound in interest rates causes all sorts of huge problems. Deflation pushes up real rates to high levels. Current monetary practice has problems in solving this problem because it doesn’t address quantity, and the zero bound prohibits it from setting the price! Warren is big on what monetary policy does – sets price, not quantity. r becomes greater than g, and we live in Ebenezer Scrooge land.
And I won’t talk about the Anti-Democratic Conspiracy in Economics in light of “something economists have known since 1958 that we don’t talk about much, except in private, like in economics journals that nobody else reads.” It is too depressing to realize we’ve been strangling ourselves for 50+ years because economists are afraid of good things happening. Read that post again, and the one about Economists grabbing power, and you’ll cry. We’ve thrown away my dads productive life over misguided, harmful ideas we cannot know ex ante.
[Update: Nick Rowe is a good person to even bring the Samuelson model out to the public. Then, his “demand for bubbles” explanation is brilliant.]
But the really, really cool part comes in now. MMT plus monetary policy allows us to control r on the short end of the curve. We can always create or destroy inflation through spending and taxation. We can always peg the 3 month t-bill rate to nearly whatever we want.
We control r.
We can make r go to whatever value we like through a combination of spending and monetary policy. There is no hard constraint, just that pesky soft constraint of inflation. How much inflation is worth it to get to very high levels of growth?
I think this is what Warrens intuition was telling him when he says things like “We could have 15% real growth if we had policy right.” And this is the method on which to find that growth – the combination of fiscal and monetary policy to control r so that we live in bubble land.