Wednesday 24 December 2008

Are our leaders misrepresenting Keynes?


Central Banks appear to be citing Keynesian monetary policy as a reason for pushing down interest rates to dangerously low levels.

Yet it is far from clear that the dead economist would himself have approved of low or no interest rates.

According to his General Theory of Employment, Interest and Money, when the "rate of interest has fallen to a certain level… almost everyone prefers holding cash to holding debt which yields so low a rate of interest," as a result of which central banks can "lose effective control over the interest rate" (p. 207).

The problem, as I have noted repeatedly, is that if interest rates are low, there is no incentive to lend money, thus furthering the very “liquidity trap” that the Central Banks believe they have to resolve. As Keynes understood, people have no incentive to hold bonds (or deposits) rather than cash. In fact, the rational investor would shift their money abroad.

Rather than resolving the problem, today’s low interest rate policy is sowing the seeds of the next economic crisis by encouraging further credit expansion which, in turn, will lead to further misallocations of resources and requiring future punitive interest rate rises.

3 comments:

Anonymous said...

Keynes' "General Theory" was nothing of the sort and dealt only with Great Britain's post WW1 Gold Standard (it was set too high). It is worth listening to Hayek:

http://blog.mises.org/archives/009112.asp

not an economist said...

Can someone tell me why people are favouring the Japanese Yen over sterling? I only ask 'cos as I understand it the Japanese economy has been in recession for over ten years. What makes it anymore attractive than the British economy at the moment?

Liberal Polemic said...

An interesting question, non-economist.

I guess the former exchange rate was based on Japan's economy being weak and ours strong. Even if Japan's remains weak, if ours also becomes weak then the relative value of the Pound to the Yen must fall.

Does that make sense?