I just read a section of a report issued by Ron Paul on the gold standard, in which he made the point that interest rates during the 1800s were between 3 and 5 percent, while the developed world was on the gold standard, and that this was a realistic number for rates to fall to. However, if 100%-reserve banking is brought in along with a gold standard, wouldn't interest rates rise sky-high as people compete for a much smaller amount of dollars to be lent out?
If someone can reference some works that discuss this question I'd be very grateful.
prr:if 100%-reserve banking is brought in along with a gold standard, wouldn't interest rates rise sky-high as people compete for a much smaller amount of dollars to be lent out?
No.
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At first, yes. People would bid up rates initially, but as business failures occur and prices fall with demand, they would level out. It will, (sorry Freudian slip) would, be very painful at first with no inflation to stimulate and propagate malinvestment. As long as mistakes like propping up of wage rates or failing entities wouldn't occur, you would get back to a sound medium of exchange with reasonable interest rates.
The higher rates interest rose the more savings would occur, and the fewer borrowers would be competing.
DBratton: The higher rates interest rose the more savings would occur, and the fewer borrowers would be competing.
Exactly. If 100% reserves were instituted there surely would be a much greater demand for savings, jacking up interest rates. But interest rates go up to entice more people to save. If interest rates shot up to 20%, wouldn't you probably put more money in the bank and take advantage of that? Imagine being able to put retirement savings in the bank instead of in the stock market.
DBratton:The higher rates interest rose the more savings would occur
Don't you think you are violating here, the causal-realist approach which is so very important to Austrians? I mean, interest rates really don't cause people to save, just like how prices don't make businessmen to produce. Prices act as a guide to businessmen, but that doesn't mean prices cause production. Get it?
High savings rate causes low interest rates; and low savings rate causes high interest rates.
That is, basically, savings precede corresponding interest rates.
That's true, but think about what people do with the interest they receive from their savings: if you've got nothing planned for the money, the return makes it very tempting to reinvest it all.
Keynes must've been a fan of Brave New World; why else would he write a book about its economics?
Prashanth Perumal:Don't you think you are violating here, the causal-realist approach which is so very important to Austrians?
No I don't think I am. The Austrians hold that prices are determined by consumer preference and not by cost factors. But that does not imply that consumer choices cannot be influenced by prices. To say that would be a violation of supply and demand.
prr: I just read a section of a report issued by Ron Paul on the gold standard, in which he made the point that interest rates during the 1800s were between 3 and 5 percent, while the developed world was on the gold standard, and that this was a realistic number for rates to fall to. However, if 100%-reserve banking is brought in along with a gold standard, wouldn't interest rates rise sky-high as people compete for a much smaller amount of dollars to be lent out? If someone can reference some works that discuss this question I'd be very grateful.
If 100% reserve banking occurs, it will probably cause the interest rate in the short run to increase, since there will not be artificial credit in the banking system. However, this is a good thing, as mistakes will not continue in a boom bust cycle that contracts wealth.
Interest rates are not determined by the supply and demand for money. Instead, supply and demand for money affects the purchasing power of money. Cerebus Perebus, a change in the money supply causes an inverse change in the purchasing power.
The reason for this confusion, is because money that is created by the FED, treasury, or a fractional reserve bank goes into loans, increasing the supply of loanable funds and reducing the interest rate. But if they instead gave it to auto manufacturers, it would subsidize cars.
Schools are labour camps.
Interest rates are not determined by the supply and demand for money.
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I'm reading a lot in the replies about increased savings offsetting the decline in capital (or simply "money") available to loan--but remember this scenario is 100% reserve banking, and so all this money will be locked up in a vault somewhere. So I"m not sure at all how increased savings are going to help this scenario out, unless the lion's share of the money (chasing these nice 20% returns now being offered by bankers) is invested in time-deposit accounts like CDs, which might not be liable under a putative 100% reserve system.
However, if we are going to allow for such deposits like this to be loaned out, I'm really not sure what the purpose is in establishing a 100% reserve requirement is, if only a small percentage of clients' money is going into accounts that are liable for this reserve requirement.
Another way of saying this is, if only checkbook balances and the traditional "passbook" savings accounts (if they still exist) are liable for the 100% reserve requirement, but we aren't going to count CDs or money markets, AND if most of the savers' money were going to go into the latter, what would be the purpose of setting up a 100% reserve requirement? The overwhelming majority of savings account money wouldn't be liable for the requirement, so I'm not sure how this would head off any bank runs, or have any other effect on the money supply.
I suppose the Rothbardians would say that the interest rate would shoot up to where it should be, although, I don't buy the argument.
I'm not entirely sure on the following answer, but I think that it's not particularly helpful to speak of " the market rate of interest" without clarifying what we mean. Usually when economics speak about the market rate of interest what they mean is the aggregate of the interest rates offered on various financial instruments, and what's important to entrepreneurs (in the sense that it's the signal they use to gauge time preference) are nominal interest rates and relative prices. Ultimately prices will adjust along one margin in order to bring savings and interest in to equilibrium, I just think that 100% reserves make the system moe cumbersome
For example, if 100% reserves were implemented right now I suppose the interest rate on typical bank loans would rise. However, at the higher interest rates people would find that they'd want to save more. Money would thus be brought out of circulation and prices would drop, following this adjustment saving and investment will once more be in equilibrium. I can also imagine that as the opportunity cost of holding cash increases so too will the demand for bonds, of course as this happens their face value is pushed up and the interest rate down. Of course, the key question for prevention cycles and depressions is what arrangements will best equilibrate investment and savings. A single price (the interest rate) or literally millions of price (in the form of the price level)
By the way, as far as I can tell there's been a lot of confusion here about a basic Econ 101 question. The interest rate is a price and as such serves coordination purposes. So as the price of time, so to speak, rise people will begin to offer more credit. But this is a shift along the curve, not a shift in the curve. And as such the adjustment will be in terms of quantity but the supply would stay the same.
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prr:However, if 100%-reserve banking is brought in along with a gold standard, wouldn't interest rates rise sky-high as people compete for a much smaller amount of dollars to be lent out?
The interest rate is a function of time preference, not a function of the amount of money floating around. Monetary expansion/contraction only has a temporary effect on interest rates.
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I'm reading a lot in the replies about increased savings offsetting the decline in capital (or simply "money") available to loan--but remember this scenario is 100% reserve banking, and so all this money will be locked up in a vault somewhere.
No! Lesser dollars in the economy means lesser expectations on returns out of entrepreneurial ventures. So, interest rates would not shoot up.
GilesStratton: By the way, as far as I can tell there's been a lot of confusion here about a basic Econ 101 question. The interest rate is a price and as such serves coordination purposes. So as the price of time, so to speak, rise people will begin to offer more credit. But this is a shift along the curve, not a shift in the curve. And as such the adjustment will be in terms of quantity but the supply would stay the same.
It is reasonable to believe that as the price of using money rises, more people would offer it--that the amount of credit could expand. But I guess my question here is, whence it would come? Remember, the reserve requirement on savings accounts would be rising from the 2-10% level it is now, to 100%. So what other sources of credit would arise? Yes, companies could always float bonds, but then the issue remains, that there would be a credit contraction, which means that more people would be chasing the same amount of credit open to companies that float bonds--which is why I see interest rates as rising (at least in the short term, and I"m not sure how they would fall over the long term, unless more credit were to come to the marketplace).
I'm beginning to think that this will end up being a discussion on the basis of an infinite regression--yes, one could always say people would invest in bonds rather than the stock market, but then this means that money for companies would no longer be available via stock offerings, etc....
In regards to the argument that interest rates are not a function of the amount of money available, but of time preferences... I'm not sure I buy that, but I'd like to see that fleshed out a bit. With an intense credit contraction like I see happening in this scenario, how could rates not skyrocket? Or, what would act to keep them from rising?
prr: I'm reading a lot in the replies about increased savings offsetting the decline in capital (or simply "money") available to loan--but remember this scenario is 100% reserve banking, and so all this money will be locked up in a vault somewhere. So I"m not sure at all how increased savings are going to help this scenario out, unless the lion's share of the money (chasing these nice 20% returns now being offered by bankers) is invested in time-deposit accounts like CDs, which might not be liable under a putative 100% reserve system. However, if we are going to allow for such deposits like this to be loaned out, I'm really not sure what the purpose is in establishing a 100% reserve requirement is, if only a small percentage of clients' money is going into accounts that are liable for this reserve requirement. Another way of saying this is, if only checkbook balances and the traditional "passbook" savings accounts (if they still exist) are liable for the 100% reserve requirement, but we aren't going to count CDs or money markets, AND if most of the savers' money were going to go into the latter, what would be the purpose of setting up a 100% reserve requirement? The overwhelming majority of savings account money wouldn't be liable for the requirement, so I'm not sure how this would head off any bank runs, or have any other effect on the money supply.
You seem to have a pretty fundamental misunderstanding about the difference between saving/investing and cash hoarding. You're right that in 100% reserve banking, money that is placed in a vault by demand depositors will not be lent out. But, and this is hugely important, placing money in a vault is NOT saving/investing. Rather, it is "cash hoarding", which serves an important market purpose in itself, but, unlike saving/investing, does nothing to build up a complex system of production. But to save/invest, you give up present money now in hopes of a high return in the future, accepting the risk that you may even lose some or all of the money invested.
In this thread, when people are talking about how higher interest rates serve as an incentive to save/invest, they're not talking about just taking their money and putting it into a vault where it will just idly sit (and I don't attach any negative connotations to the word "idle", as Keynesians often do), they're talking about real investments, where the present money is given up in the hopes of a future return. Stocks, CDs, all sorts of options are possible investments.
One of the many reasons Austrians are against fractional reserve banking is that it muddles the difference between cash hoarding and true savings -- money is being invested by the bank (i.e. the bank loans out demand deposits), yet depositors are given the impression that all of their money is in the bank, waiting to be withdrawn in its entirety at any day in the future. Today, many of the people who are aware -- and there are many who aren't aware -- that the money they put in the bank doesn't not just sit idly but is loaned out might consider that what they are doing is saving, and to the extent that they don't intend to take all of their money out of the bank, thus depriving the bank of funds to loan out, I suppose it can be argued that they are saving, at least a little bit. But a fractional reserve bank will absolutely overshoot its depositors' true savings proportions (i.e. what they would choose to save/invest in the absence of fractional reserve banks), simply because a bank will always try to maximize its interest income by loaning out deposits as much as possible. Hence the "distorted", artificially low interest rates that lead to malinvestment, since no one was ever actually voluntary setting aside enough funds to save and support the investment.
Alex M: You seem to have a pretty fundamental misunderstanding about the difference between saving/investing and cash hoarding. You're right that in 100% reserve banking, money that is placed in a vault by demand depositors will not be lent out. But, and this is hugely important, placing money in a vault is NOT saving/investing. Rather, it is "cash hoarding", which serves an important market purpose in itself, but, unlike saving/investing, does nothing to build up a complex system of production. But to save/invest, you give up present money now in hopes of a high return in the future, accepting the risk that you may even lose some or all of the money invested.
You're mistaken about this point. I raised the issue of putting money into other "savings" earlier, but then indicated that the more money went into those types of accounts that would not be liable under the 100% reserve requirement, the less relevant this requirement would be. See the quote from my second post:
So I"m not sure at all how increased savings are going to help this scenario out, unless the lion's share of the money (chasing these nice 20% returns now being offered by bankers) is invested in time-deposit accounts like CDs, which might not be liable under a putative 100% reserve system.
Alex M:But, and this is hugely important, placing money in a vault is NOT saving/investing. Rather, it is "cash hoarding", which serves an important market purpose in itself, but, unlike saving/investing, does nothing to build up a complex system of production.
It needn't, but it can.
GilesStratton: It needn't, but it can.
How so, assuming it's not being lent out of the vault?
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