Wednesday, August 17, 2011

The Rentier Class and Monetary Policy

Reihan Salam flags this bit from J.P. Morgan report on why there has been so much resistance to the Fed’s actions:

To understand why, consider Mr and Mrs James Rentier (a), an apocryphal family in their early 50’s living in upstate New York. The Rentiers are middle income: $80,000 in adjusted gross income, 3 children and $300,000 in savings after setting aside 10% of their income over the last 30 years. Over time, as they aged and given their limited safety net, they shifted their investments into cash and short term fixed income. The current tax system is friendly to the Rentiers; at their income level, after standard deductions, available child tax credits and the payroll tax holiday, their fully-loaded effective tax rate is around 14.5%. But now consider the impact of QE (quantitative easing) on this family. Money market yields, in a normal cycle, are ~ 2% over core inflation; that would be around 3.5% today Zerophilia deprives this family of ~$8,200 per year in after-tax interest income. How substantial is that? Let’s normalize interest rates, and then compute the increase in effective tax rates that results in the same amount of after-tax income the Rentiers have today. As shown below, the punitive impact of QE on this family is the same as raising effective tax rates by one third. These are the unintended consequences of QE: a wealth transfer froms avers to the over-leveraged, and perhaps, to owners of stocks, although this latter channel isn’t working that well. Note: this is before considering the impact of rising commodity prices on the Rentiers (the Fed rejects the notion that QE affects commodities).

The implication here is that all monetary policy doe is lower interest rates, serving as an implicit tax on the holders of capital. One hears a lot of this talk, and it’s worth wondering why there seems to be so much political backlash against federal reserve easing actions.

The key here though is that this analysis narrowly focuses on the short-term impacts of easing against the broader impacts. In the short term, more easing (say, in the form of further quantitative easing) may well lower long-run interest rates (the liquidity effect). But in the long run, easing serves to increase total nominal spending, and so expectations of future inflation. This is the Fischer effect, and it works to raise long-run interest rates.

A lot of people seem to be upset right now that interest rates are low; but that’s not
solely a function of the Fed. The “natural” Wicksellian rate of interest is low due to a weak economy. Successfully targeting a future path of nominal spending higher than that expected today would lead to a robust economic recovery and higher inflation expectations — and so actually higher interest rates in the future. That’s why Milton Friedman identified low interest rates with tight, rather than loose, money.

So phrasing this issue as a “economic recovery on one hand, low rates on the other” dilemma is short-sighted. The path to both economic recovery and higher rates lies in more easing. And if you look internationally, the countries that have done the most to implement expansionary monetary policy have the higher interest rates. In Sweden, Lars Svensson has pioneered a variety of unorthodox monetary policy tools — including setting a negative interest rate on reserves, and robust quantitative easing. The result has been an economy that has recovered to a pre-crisis trend rate of growth:

That has provide the Swedish Central Bank with sufficient leeway to see rising interest rates, led by Central Bank rate hikes. By contrast, Japan has been far more reluctant to embrace an expansionary monetary policy in terms of raising its price level; and so has seen low interest rates for decades. It’s hard to think that Japan is a better place for rentiers than Sweden.

There’s been substantial discussion of how it is that people in the economy somehow don’t perceive this. Brad DeLong has argued that the Great Depression era rentier class was opposed to inflation as their profits were entirely insulated from the suffering of common folk. By his argument, people are sufficiently

It’s hard to know what to think about this. The rentier class in the Great Depression was also devastated by overall economic losses. A reluctance to embrace expansionary monetary policy in an environment of a persistent demand shortfall and very low inflation doesn’t seem to make too much private economic sense. One imagines that the rentier class is simply mistaken

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