Continuing Education... Scott Sumner on Interest Rates

EconTalk Extra
by Amy Willis
Scott Sumner on Interest Rates... Leonard Wong on Honesty and Et...

EconLog's Scott Sumner argues in this week's episode that too many people reason (incorrectly) from a price change, causing confusion about the factors behind today's continuing low interest rates. The conversation also touches on the role of the Federal Reserve and its monetary policy, and the effects of regulation on issues such as inequality.

Now we'd like to hear from you. Use the prompts below to spark conversation in your classroom or at the dinner table. Or simply use them to help further your own understanding. However you use them, we'd love to hear about it in the Comments.

interest rates2.jpg

1. What is Sumner's explanation for why interest rates have fallen so low? How does he describe the state of the economy's health today, especially in comparison to the immediate aftermath of the financial crisis? To what extent do you agree with his diagnosis of the current state of the macroeconomy?

2. In discussing the "secular stagnation" thesis, Sumner argues that the economy today has two distinct sectors. What are they, and how do they help explain variations in interest rates today? What does this suggest to you about the future of individual investment and employment opportunities? Explain.

3.Toward the end of the interview, Roberts bemoans his 15 year old son's incentives to save in the face of low interest rates. How is Roberts' complaint the opposite of Piketty's, according to Sumner? How do you think Piketty would respond to this claim? (Hint: You might want to revisit Roberts' interview with Piketty from September.)
If Piketty is right, why isn't @EconTalker's son getting rich?

COMMENTS (18 to date)
Brendan riske writes:

1: he seems to suggest it is about lack of demand for investment. I think that is part of the issue. But where he is completely wrong is in central bank stimulus. It has a massive effect on interest rates. Buying up government bonds by the trillions and loaning money at 0% to banks is all about raising asset prices. The sheer magnitude of it means it cannot be discounted. His only defense of free money policy is that it would lead to higher inflation. In theory, he is correct, but in practice we see how the newly created dollars (and yen and euros) flow into financial markets and feed a cycle of asset price inflation. It is only sustained by central bank injections and low interest loans to banks. The inflation is also now making its way into the real economy. Look at food, housing, and health care particularly. He also seems to discount the effect of fractional reserve banking on expanding credit without savings from ordinary peoole. I think he has a very flawed picture of the macro economy, 47% of which by gdp comes from the finacial sector. It's all about finalization now. This has crushed opportunities for real business, lowering demand for loans.

3: he is terribly mistaken about piketty. Piketty is on point with how bad inequality has become. He also highlights how returns to capital are higher than returns in the real economy. This is true! There is and entire system dedicated to protecting the finacial sector, making sure the stock market rises and keeps boasting asset prices. They are owned by those with wealth. Very few ordinary people have access to those returns. Instead, the deposit their meager earnings in a bank, only to earn nothing and watch their purchasing power be crushed. It's brutally unfair, and needs to end.

In conclusion, he really missed the ball here. To little attention to massive central bank stimulus. Completely misses the point with piketty. Wrong on lack of inflation in practice. Examine how the financial sector and bank sectors have actually acted in responce to cb actions. How else does he explain negative interest rates? They are the most bizarre current phenomenon, should not exist in theory, and are only possible because of massive bond buying by banks. The price of bonds has been bid so high because everyone knows their is a buyer of last resort, who will buy at any price, the cb. They are front running by buying bonds, pushing the rates on them all the way past zero. People in america are catching on to what has happened, and will not continue to be punished just to save the huge returns for the wealthy from their asset price increased. Eventually, though they are not used to it, they will hoard cash and switch to precious metals.

Michael Byrnes writes:


Newly created money cannot "flow into asset markets and feed a cycle of asset price inflation" without affecting the broader economy. Money doesn't flow into asset markets: for every dollar used to buy a stock goes not "into the market" but "to the seller"

Brendan riske writes:

Of course it eventually makes its way into the broader economy. The point is that the transmission mechanism put huge amounts of money into that sector. What the financiers have done with their profits it's obvious,the have bought luxury goods including property, and more finacial assets to keep a steady flow of income from gains. The political economy of this phenomenon is that one group in society was favored at the expense of others. Hence the huge inequality we are seeing now, and the depression of the real economy as money flows into finance. Financial "innovation" isn't improving the economy. They produce nothing of real value.

Nick writes:

I was shopping in the local CVS with my daughter who is in 5th grade. The jellybeans were 75% off, but they clearly weren't selling (there were still a ton of them left), and my daughter said, "They are really cheap because nobody wants to buy jellybeans after Easter."

She would not be puzzled by the low rate of investment happening at the same time as low interest rates (ok, she will in another 10 years when she is old enough to know that the price of borrowing is the interest rate). But professional economists should know better.

jw writes:

MB and Brendan,

You are in agreement, but at two different times. The money printing that the Fed is doing immediately and disproportionally benefits the financial sector (this is called the Cantillon Effect) because it is specifically designed to do just that. It eventually makes its way into the broader economy, and will at some point (that I cannot predict) will result in much higher inflation.

Remember, the Fed does not work for the public or even the government, it works for the banks (with theoretical oversight by Congress - most of whom couldn't explain QE on an open book test...).

And going to Russ' previous talks on regulatory capture, Greenspan makes $250K/day in speaking fees to banks and Bernanke just joined Citadel, one of the primary beneficiaries of QE. It has not been disclosed, but you can bet that he is making multiple millions of dollars per year.

It is a very difficult situation to overcome.

Michael Byrnes writes:


It doesn't really work that way. If markets expected future inflation, prices would rise NOW (or would already have done so). Inflation is driven by market expectations, and right now there is minimal expectation that the massive excess of reserves held by banks will ever drive prices up.

BW writes:

The fed balance sheet is not making its way into the broader economy very quickly, and I suspect the media is mis-interpreting the effect of QE on the stock market. Few thoughts.

First, the fed moves generally follow the market increases/decreases in rates.

Second, the "printed" money from the fed has indirectly been transmitted to bank reserves. Banks now have higher capital requirements. If the fed did not "print" money, there would have been a massive contraction in money supply.

Third, I believe Brendan is mostly correct when he says the system protects wealthy. I don't believe this is via diabolical design, just a consequence of stable money promoting economic growth. The quickest way out of the great recession would have been to increase the inflation target and print even more money. Ordinary workers could care less if inflation is 2% or 4%. Labor costs will adjust themselves through market forces. On the other hand, Bond holders, or those trying to protect their wealth would get crushed.

brendan riske writes:

@Michael Byrnes

Why would prices rise now? Demand for food, helathcare, and housing is high, but the people who need it have no money! raising prices will do nothing but reduce quantity consumed. That why they are staying flat.

What mechanism to you expect to correct for inflation? The banks are not doing it. investors aren't doing it. Just because they don't expect it to happen doesn't mean it wont. And why is asset price increase not calculated into inflation?

I'm with JW on this. There is alot of theory about what should happen. But if you look at the reality, there isnt a good way of arguing that central banks arent boasting asset prices and keeping rates low. Functionally, that is what is going on.

jw writes:


There is inflation where the money is. Art prices are going through the roof, as is NYC, DC and SF real estate and stocks. The Fed specifically set the goal of raising asset prices and they have succeeded, but as the Cantillon Effect argues, it is primarily in the areas where the first recipients spend it.

The rest of us are seeing inflation in food prices, but the current energy situation is masking it in the general inflation numbers.

Also, see for an explanation as to how inflation statistics have changed over the years. Like current BLS data, I do not trust many statistics coming out of DC, there are just too many ways to manipulate them now.

In answer to Question 3 above, Piketty would argue that either:

1. R included all investment returns, not just the interest rate, so R>G still holds.
2. If not, then G is overestimated, that the real economy is doing much worse than the official measurement.
3. That there is simply a temporary imbalance in the long term R>G effect.

It doesn't really matter as Piketty is wrong on just about every count in his book (see my comments in that thread...).

Michael Byrnes writes:

Oh, tragedy, art price inflation. There is just nothing worse in the world than seeing prices of luxury items purchased by the vain rich soaring through the roof. My heart just bleeds for rich folks who are forced to part with extra millions on art purchases - it's a real injustice.

Steve Stofka writes:

Here is what I heard Scott Sumner saying. Using the supply/demand graph ($ on x axis, interest rate % on y axis): demand for investment has shifted to the left (demographics, new housing demand low, new tech companies don't require huge capital investments). Even if the investment supply curve doesn't shift right, interest rates come down as per the standard supply/demand model. The incomes of people in Asian and emerging countries are improving. These are people who save a lot of their income compared to Western Europeans. Those savings dollars are flowing into the global investment pool, shifting the supply of investment to the right and down the shifted demand curve for investment. Fed monetary policy has not been expansionary because the supply and demand for investment dollars have found their equilibrium at both a lower quantity of dollars and a lower interest rate.

Brendan riske writes:

I love when people say "asia just has higher savings rates". Totally cop out. Most people in China and India have no say in what happens to their income. It's all government controlled. High saving where part of official policy, not the result of people's natural desires. As incomes go up, and citizens have more of a say in it, consumption will increase and savings will decrease.

Again, there is a glut of money out there from central bank policy looking for yield anywhere. That alone can drive down rates.

jw writes:


I care not a wit about rich people buying art. But it does represent to me a canary in a coal mine. It MAY be one of the leading indicators of much higher inflation as the rich put their savings into hard assets regardless of price instead of keeping them in cash.

Mark Maguire writes:

I would like to learn more about the concept you mentioned "Real interest rates, the productivity of the economy as a whole...".

I'm not a student of economics and I don't understand how interest rates equal productivity.

If possible, please post a link to an introduction to the concept.

Dale Eltoft writes:

Toward the end there is discussion about the ills of regulation. It touches on the usual arguments. I'd like to suggest an additional ill effect which is somewhat indirect and hidden. Whenever rules or regulations are created, creative people find ways to game the system. Ways that almost certainly are not within the intent and spirit. In most cases the ones able to benefit from gaming are the larger more wealthy for whom the cost to figure the angles are a relatively minor percentage of their business or ones that have sufficient capital to leverage a small advantage. So often regulation is the friend of the large corporations and the wealthy.

Scott Sumner writes:

Brendan, There is no question that QE has had some impact on asset prices, but I think you may have overstated that impact. In efficient markets the total impact is priced in by the time that QE is announced. Recently we've continued to see US stocks appreciate even after the QE program ended. In my view QE modestly boosted stock prices because it prevented the sort of double-dip recession that we saw in the eurozone.

I don't recall saying that Piketty was wrong about inequality increasing; my view is that the issue is complex, and he took a rather simple approach.

Michael, I agree about money flows.

BW, I mostly agree, although the effect of easy money on the wealthy is a bit more ambiguous, as bond and stockholders may have different interests.

JW, The shadowstats view of inflation has been discredited. In any case, even if it were correct it would merely shift the puzzle to low NGDP growth. Easy money results in high NGDP growth.

Cantillon effects are greatly overrated in my view. You'd get roughly the same macro effects from money injections if the Fed bought gold, or a global index fund of stocks.

Steve, That's about right, although most textbooks refer to the supply of saving, not supply of investment (but I see your point.)

Brendan, You said:

"Most people in China and India have no say in what happens to their income. It's all government controlled. High saving where part of official policy, not the result of people's natural desires."

That's not even close to being true. The government in China does do substantial saving, but so does the private sector. Indeed when Chinese move to America they continue to be relatively high savers (I'm married to one.) Saving is fairly high in places like Singapore and Hong Kong, listed as having the most economic freedom in the world according to several surveys.

Mark, I'm going to suggest starting with a basic principles textbook, say the ones by Mankiw, or Cowen/Tabarrok. For a more in depth look Irving Fisher is excellent, indeed he developed the modern theory that interest rates reflect both time preference and productivity factors (which feed into supply and demand for credit.

I'd guess there are now some basic explanations online, if you have limited time. Have you checked sites like Wikipedia?

Dale, Very good point.

Hesam writes:

The decline in real interest rates.

What (if any) is the relationship between discount rates for individuals and the real interest rate in an economy?

We know higher education and income are associated with lower discount rates for individuals. Given the trends on income and education worldwide (both have risen dramatically) the average person should have a lower discount rate compared to, say 50 years ago.

So why can't we explain the decline in global real interest rates as an aggregate manifestation of this trend??

Christian Larsen writes:

The thing that most tweaked my interest was the shift of the investment curve to the left. Why?

One contributing factor may be the digital disruption that is going around the world. In most cases I've observed new businesses that "disrupt" seem to harvest some latent capacity in the economy and if the capacity is indeed latent then the additional output comes with low need for investment.

To give an example. AirBnB delivered 37 room nights in 2014. Doing some back of envelope calcs if the same room nights were delivered by a standard hotel group then $28B of investment would have been required to deliver these room nights. This investment therefore did not occur. The forecast are that AirBnB will triple room nights in 2015 so thats even more investment that is not needed.

In terms of world economy this is small but investment is driven by expectations. How many other industries are pulling back on investment and hence borrowing because of such disruption or expected disruption.

Whats happening is that the rate of disruption seems to be at unprecedented levels is occurring across many industries. This could all be adding up to a significant shift in the investment curve to the left. Probably the biggest impact will be in finance industry. The level of new fintech start ups is rising fast.

Taxi anyone.

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