Aug 10, 2022Liked by Peter Nayland Kust

"Pressure is being added for another large rate hike in September. "

Good. Interest rates should be always be higher than inflation, otherwise the real cost of money is negative, which leads to malinvestment thereof.

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If we presume the traditional relationship between interest rates and inflation, the ideal interest rate should always equal the inflation rate. That would be the "neutral" interest rate.

If interest rates are higher, the "cost" of money inhibits consumption and overemphasizes savings.

If the interest rates are lower, the negative "cost" of money inhibits savings and overemphasizes consumption.

Of course, the only way to achieve such a dynamic equilibrium is for central banks to quick mucking around with interest rates and allow market forces to do their thing.

But the larger problem is that we may be in an era where the correlation between inflation and interest rates might not be a solid as we are led to believe. Consider: if interest rates need to be higher than inflation then interest rates in the US are still several orders of magnitude too low, and July's drop in inflation should not have happened.

Which makes the Fed policy erroneous by definition because it hinges on a wrong understanding of the interest rate/inflation dynamics in play.

I'm not at all certain that interest rates are decoupling from inflation, but there are oddities about the current situation which make me wonder.

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I'll respectfully disagree that "neutral" is optimal. If I have money, why would I lend it to you (or a bank) at a "neutral" interest rate? Savings are good. Savings should represent wealth/value that has been created, but not yet consumed, i.e. surplus wealth that can be invested, hopefully in a manner that produces more value/wealth and thereby grows the economy. Without surplus wealth being invested, the economy becomes a zero-sum game.

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In the ideal market economy, a neutral interest rate would serve to maintain the dynamic equilibrium of markets for goods and services, which is also the point of optimum output.

If interest rates are higher than this neutral rate, yes, savings is encouraged, but to a degree where overall economic output is reduced.

If interest rates are lower than the neutral rate, then consumption is encouraged and savings discourage, to a degree where capital available for investment is inadequate to achieve optimum output.

As a lending market participant, you would naturally lend at the highest rate you could achieve within the lending marketplace. However, competition for borrowers would push interest rates down to an equilibrium--or "neutral"--rate.

There's a considerable body of economic thought devoted to the concept of the "neutral" interest rate, although as Larry Summers points out, the current financial mess we're in is challenging most of the theoretical underpinnings for the concept, at least insofar as the neutral rate can be identified and targeted explicitly by a market-distorting central bank.

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The "neutral" rate can never be identified. Which is all the more reason why the Fed should dissolve itself for good. Trying to identify the neutral rate is seeking a pot of gold at the end of a rainbow.

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I agree at least to the extent that the neutral rate cannot be calculated in advance. Which makes the entire Fed strategy of targeting inflation via interest rates extremely problematic.

However, if one assesses that the "neutral" rate will always be equal to inflation, it theoretically would be possible to determine if interest rates were at, above, or below the neutral rate for any set period of time in the past.

I certainly agree with the idea of ending the Federal Reserve altogether, if for no other reason that it has completely failed in its notional mandates of price stability and maximum employment.

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Aug 11, 2022Liked by Peter Nayland Kust

"Maximum employment" was stuck in the Fed's mandate to sabotage it. Most of us can chew gum and walk at the same time. Maximum employment/price stability is like patting your head and rubbing your tummy at the same time. Good luck.

Why didn't all associated with the Fed resign when the "maximum employment" proviso was stuck in there?

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Well stated, but does anyone associated with the Fed look carefully around the world? Doesn't seem so.

On the verge of a war with China.

On the verge of a more serious war with Russia.

Horrible laws being passed to try to make Biden look semi-ok in November.

War on fossil fuels getting more and more serious.

US taxes going up.

What have I left out?

The Fed should be abolished, but, so long as it exists, it should take a hint from the secret of telling a funny joke: timing.

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