Thursday, May 26, 2011

The OECD, the unemployed, and sovereign debt burdens

Matt Yglesias and Paul Krugman are rightfully pulling their hair out over the OECD call to raise interest rates. As far as I can tell, this is absolutely bizarre on three levels:

- If you are Keynesian/monetarist/mainstream of almost any type of economist it's obviously bizarre to call for increasing rates when unemployment is still so bad. Both Krugman and Yglesias make this point.

- If you are not a Keynesian/monetarist/mainstream economist but instead are an old-school moralist stable-prices fuddy-dud, then it's still crazy because as Yglesias points out, the OECD's own inflation projections are below target!

- But on top of all that, the one last hold-out for the moralizing fuddy-duds is the sovereign debt burden issue. Maybe they're not paying attention to unemployment, and maybe they're still worried about inflation despite their own forecasts, but all these guys at the OECD and IMF are always worried about "another Greece". Pushing up interest rates doesn't help countries that are struggling under a large debt burden, and a sovereign default is a lot scarier than having a modest "inflation tax" erode it away, because a little inflation doesn't spook the herd of international investors in the same way that a default does.

So this call doesn't make sense on a variety of fronts, even if you're the most Andrew Mellonesque, economics-as-morality-play international bureaucrat.

The only way it does make sense, I suppose, is if you think interest rates are artificially low and that that distorts the capital structure, setting us up for another bust and you wouldn't particularly miss modern, deficit-incurring state institutions. But I don't think these sorts of people are heavily represented at the OECD.


  1. I don't know how I fully feel about this. On one hand the unemployment situation and trade deficit has been getting better since QE II and despite outcries about inflation I'm hardly convinced. On the other hand I still do have some Austrian tendencies in regards to low interest rates setting off another business cycle. I'm interested in hearing what Dr. Murphy and jonathon have to say about this though.

  2. The question is - are interest rates really too low?

    I think a lot of ABCT is quite good. What is normal and what is artificial is the real sticking point.

  3. That's a pretty good question and I've never thought about it that way. Increasing the interest rate higher than it's natural rate(assuming we knew what it was) during a recovery period could also have some detrimental effects.

  4. And the Keynesian argument is that liquidity preference drives the interest rate too high and that's what causes the crisis.

    Austrians more or less think interest rates are too low in the boom and right in the bust. Keynesians more or less think interest rates are right in the boom and too high in the bust.

    ABCT is very interesting to me. This fall, I hope to dedicate a little time to tacking a capital structure onto an IS-LM model to show how the ABCT mechanisms can be sensible in other frameworks.

    But I think people spend too much time spelling out those interesting little modeling tricks and insights to each other and too little time elaborating on the fundamental difference of opinion: the interest rate itself.

    You can have all the modeling trappings of ABCT you want, but if you have a Keynesian interest rate theory then the problem is that the capital structure is too short in the bust - not that it is too long in the boom.

  5. Tight money is a great way of making it difficult for people to pay their debts. We don't want tight money; but what interest rates do is another matter. Bill Woolsey argues that higher interest rates may be a sign of recovery, but it depends on their cause. If higher interests rates are a product of the Fed shrinking the supply of base money, then we have tight money. If the higher interests rates are a result of returning NGDP to something nearer its pre-crisis trend, then we do not have tight money. In either case, interest rates rise; interests rates are uninteresting rates in this respect.

  6. Daniel,

    That's interesting about the Keynesian model. I was going to start Time & Money after you recommended it to me, but I ended up finding a econ textbook lying around that covers the major schools(neoclassical, keynesian, monetarism) and their models in the macro section. I've been self-teaching myself(along with formal classes) for over the past year and I figure I should become familiar with the other major schools. At the least it'll help going into Time & Money and it'll probably end up changing my views slightly.

  7. Lee -
    Yes, clearly. From context here obviously we're worrying about the tight money variety. And why would the people who have been railing about sovereign debt woes be wanting this?

  8. Haha "fuddy-dud."

    At least you gave the Austrians an anonymous shout out at the end.

    "The question is - are interest rates really too low?

    I think a lot of ABCT is quite good. What is normal and what is artificial is the real sticking point."

    That's why I'm so insistent on interest rate theory with you. If I'm correct that the interest rate is determined by time preference (mostly), then deviations from that norm by extra-market institutions sets off an unsustainable bust because the maladapted structure of production won't match actual consumer demand. The capital structure is a representation of time preference, which is just another way of saying that the structure of production mirrors is supposed to mirror what consumers actually want.

    I seem to recall you disagreeing with this analysis some time ago.

  9. I'm a bad proofreader. Sorry.

    The capital structure is a representation of time preference, which is just another way of saying that the structure of production is supposed to mirror what consumers actually want.


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