Interest rate: deflation, inflation

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Nielsio replied on Tue, Mar 23 2010 9:05 AM

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LibertarianfromGermany:

Am I the only one thinking that the reason the interest rate tends to stay above the inflation rate is because if it didn't (ie lending out would equal a loss in purchasing power) potential borrowers would just switch to commodities (i.e. gold) to at least retain most of their purchasing power? Of course governments can try (and often will) counter this to a certain point with taxes on commodities, but the point stays that if the inflation rate is continually higher than the interest rate, switching to gold would in the long run pay off even with a high tax for the initial purchase. I mean - this is basically why so many Austrians are currently investing in PMs.

If the source of inflation is government printing, then they generally tax you for capital gains (including on gold). So at least legally, that's not a complete answer to the question. Also, loaning sub-inflation would still benefit them. And if your answer is what Hoppe means then I would have expected him to bring it up. He didn't, and it looks to me like he's only comparing it to not-lending.

If the source of inflation is gold mining under a real gold standard, then your solution doesn't exist unless people switch to a different commodity. Would there always be a different commodity that people could switch to? Including if we take into account the effects of all most people switching? Seems rather radical, and also not really what Hoppe would have in mind here.

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Nielsio replied on Tue, Mar 23 2010 5:16 PM

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I emailed Hans Hoppe my question and this is what he replied:

"[..], expected inflation (deflation) reduces (increases) the demand for money and brings on the expected event: inflation (deflation) immediately to yield a positive interest rate in every case."

Can anyone figure out what that means exactly?

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onebornfree replied on Tue, Mar 23 2010 5:42 PM

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Nielsio:

I emailed Hans Hoppe my question and this is what he replied:

"[..], expected inflation (deflation) reduces (increases) the demand for money and brings on the expected event: inflation (deflation) immediately to yield a positive interest rate in every case."

 

Can anyone figure out what that means exactly?

He appears to be saying that regardless of demand for money increases or decreases on the supply, due to general expectations for the future, that a positive interest rate is always inevitable.

In other words, regardless of increase or decreased demand for money,[perhaps in relation to an assumed steady supply?], a zero, or negative interest rate is an impossibility.

Maybe

Regards, onebornfree.

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filc replied on Tue, Mar 23 2010 5:46 PM

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Nielsio:

expected inflation (deflation) reduces (increases) the demand for money

1. Expected inflation reduces the demand for money

This is the demand for money(Cash). People have no desire to hold onto money(cash) and instead people prefer to:

A) Spend their money NOW and get tangible goods while their purchasing power remains in tact

In other words expected inflation drives the motive for heavily consumer based economy supporting things like retail. People prefer to consume NOW rather then later as they realize their purchasing power is shrinking.

B) Through their money in a high risk high gain/loss investment vehicle

Since less people are saving this dwindles the money stock, naturally raising the price for credit. (Supply and demand). When interest rates rise naturally it deters borrows from borrowing while the cash saving stock slowly starts to grow.

2. Expected deflation increases the demand for money.

A) Save their cash now and buy tangible goods later as their purchasing power increases over time

People prefer to consume later rather then now as they know their purchasing power will be greater, it is growing.

B) Savings in straight cash allowing the outright purchase of higher order goods, or slower but higher secured investment vehicles

Since more people are savings, the money stock goes up. The demand for credit becomes low because there is so much savings. As a result interest rates drop due to growing reserves and an attempt to attract customers

Thats how I gather it.

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Nielsio replied on Wed, Mar 24 2010 1:01 AM

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Robert Murphy helps out:

--
I see what you're saying, and yes it seems there is some tension between the treatment of the two cases. I guess you're right that in principle someone would be willing to lend at 5% even if price inflation were 10%, because that's better than sitting on your money and earning a nominal 0%.

It's an interesting point I've never really thought about it. Economists (not just Hoppe) routinely say that investors insist on a real return, which means getting at least the rate of inflation. I guess if you already believe in time preference, then the result pops out, but you're right it's not a separate argument for it.
--

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z1235 replied on Wed, Mar 24 2010 8:29 AM

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As I said in the first sentence of the first reply in this thread:

"You can demand any rate (and at any risk level) you want but there's no guarantee that the market will give it to you."

The argument that the rate of return on your loan MUST be higher than your inflation estimate over the life of the loan is the same as saying that the price for the shares in your company that you are selling MUST be higher than your earnings or discounted cash flow estimates. In either case, you'll get whatever the market will pay for what you're selling and not a penny more. There are no guarantees or floors on prices in a free market. 

Z.