Friday, May 22, 2015

The Truth about Negative Interest Rates:The Originary Interest Rate vs. the Nominal Market Interest Rate (wonkish)

By Robert Wenzel

In an article at Institutional Investor, Vineer Bhansali, a managing director and portfolio manager at PIMCO, recently quoted Loyola University Professor Walter Block on negative interest rates and contrasted his view with that of Harvard University Professor Greg Mankiw.

Dr. Block has emailed to EPJ this response:
I thank this author:

Bhansali, Vineer. 2015. “Look at Negative-Yielding Bonds as Insurance.” May 20;;

for mentioning an old publication of mine:

Block, Walter E. 1978. "The Negative Rate of Interest: Toward a Taxonomic Critique," The Journal of Libertarian Studies: An Interdisciplinary Review, Vol. II, No. 2, summer, pp. 121-124;
Bhansali begins by quoting me as saying that a negative originary interest rate is impossible. I based this on the following statement from Mises:
"Time preference is a categorical requisite of human
action. No made of action can be thought of in which
satisfaction within a nearer period of the future is not
- other things being equal - preferred to that in a
later period. The very act of gratifying a desire implies
that gratification at the present instant is preferred to
that at a later instant. He who consumes a nonperishable
goad instead of postponing consumption for
an indefinite later moment thereby reveals a higher
valuation of present satisfaction as compared with later
satisfaction. If he were not to prefer satisfaction in a
nearer period of the future to that in a remote period,
he would never consume and enjoy. He would not
consume today, but he would not consume tomorrow
either, as the morrow would confront him with the
same alternative."

But, it would appear that Mr. Bhansali, to be kind, has a different understanding than I, and Mises, of what exactly originary interest rate is. For in his next paragraph he quotes Prof. Greg Mankiw to the effect that it may be time to go negative on interest rates. What kind of interest rates is the latter discussing? Originary ones? No, not at all. Rather, nominal market interest rates!

Of course there are times when such interest rates can go below zero, but this has nothing at all to do with the originary interest rates I was discussing.  There is a world of difference between nominal monetary and originary rates of interest, something that appears to be eluding both Bhansali and Mankiw.

Best regards,


Walter E. Block, Ph.D.
Harold E. Wirth Eminent Scholar Endowed Chair and Professor of Economics
Joseph A. Butt, S.J. College of Business
Loyola University New Orleans
 RW note:

Percy Greaves in Mises Made Easier explains the originary interest rate this way:
The inherent component of gross or market interest rates which represents the ever fluctuating ratio between the values assigned to want satisfactions in the immediate future and those assigned to want satisfactions in the more distant future, In short, the difference between present value goods and gross market goods. In addition to the originary interest component, gross or market interest rates include the entrepreneurial component (uncertainty of repayment) and the price premium component (anticipated changes in the future values of the particular goods, including the monetary unit, under consideration.) 
Whenever use see a negative nominal interest rate, it is the case that the storage cost for the safe and convenient method of holding money in a bank is greater than the combined other factors that Greaves mentions that combine to form the nominal interest rate.

It should further be noted that Mankiw doesn't really believe that interest rates can go negative beyond storage charges either. This is different from the implication that Bhansali leaves that there is a difference in perspective between Block and Mankiw on this. In the Mankiw NYT column that  Bhansali quotes from, Mankiw writes this, which is really saying the same thing as Block and Mises:
The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less.
When Mankiw then moves to call for a negative interest rate, what he is really doing is calling for a tax, disguised in typical mainstream mathematical formulas that hide that what he is really calling for.

 Bhansali, it appears has fallen for this trap. Here's the Mankiw tax disguised via obfuscation that only a chairman of the economics department at Harvard could pull off:
Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.
That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Later in the essay. Mankiw actually slips and makes clear he is talking a tax and not what one would normally think of when thinking of a negative interest rate:
 The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. 
At his conclusion to his column. Mankiw goes even further and seems to  make clear this call for a "negative interest rate" is really a trick:
The idea of negative interest rates may strike some people as absurd, the concoction of some impractical theorist. Perhaps it is. But remember this: Early mathematicians thought that the idea of negative numbers was absurd. Today, these numbers are commonplace. Even children can be taught that some problems (such as 2x + 6 = 0) have no solution unless you are ready to invoke negative numbers.
Maybe some economic problems require the same trick.
 Robert Wenzel is Editor & Publisher at and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics

1 comment:

  1. Since the human race is clearly not going extinct, a negative originary interest rate is not yet upon us. But some nominal or market interest rates have gone negative in the past due to legal or regulatory restrictions. And so the savings and loan industry (a creature of the government to begin with) was whipsawed out of existence. Perhaps another government creature is about to meet its demise.