Econ 101

[Forstater, Mathew]

lower interest rates are very unsure way of increasing investment--weak
empirical, theoretical, historical, support. higher interest rates have stronger
link to lower investment (for those who have had econ 101, the
interest-elasticity of investment demand is more elastic for interest rate hikes
than for interest rate cuts). as Doug or someone said (or implied), mainstream
theory has a kind of "Say's Law" of the monetary side--money supply creates
money demand. So if there are excess reserves, they will be borrowed--interest
rates will guarantee it. But after Keynes, the demand for credit is determined
by those same forces that Keynes recognized come into play in determining
private investment--investor (and lending institutions') expectations of
profitability, business and political climate, etc.  Private banks and the Fed
can accomodate the demand for credit, underwriting investment, leading to income
generating economic activity, with savings rising as a result of the income
generating investment, replenishing reserves &etc.  After Volcker, almost no one
believes the Fed can control the Money supply. But the Fed does control some
short term interest rates directly--Fed funds rate (overnight lending rate) and
the discount rate. These are the rates private banks pay to borrow from other
member banks and the Fed to borrow reserves, respectively.

If you ever want a real good laugh, order the Fed "comic books" that explain
things like "Money--How it works" and stuff like that. Just absolutely
unbelievable! I promise you, you could not come up with anything more wild if
you tried to think of the most outrageous caricature. And not just in terms of
the just plain wrong info, but this is fertile grund for some major
literary/symbolic deconstruction--the 'race' of those playing different roles,
for example--it simply cannot be believed! That is, you'll laugh until you
realize that it isn't a joke and this is 'educating' students and the public,
etc. Then you'll turn to crying.

-----Original Message-----
From: Doug Henwood [mailto:dhenwood at panix.com]
Sent: Thursday, March 29, 2001 9:54 AM
To: lbo-talk at lists.panix.com
Subject: Re: Econ 101

Bob Morris wrote:


>Ok, I'll admit it, I don't really know exactly how the
>Fed guides the economy.
>
>The want to stimulate the economy, so they drop rates.
>This means loans cost less so people are more likely to
>take a loan and build a factory or whatever.  This I
>understand.  However, doesn't the Fed also control how
>much money is in circulation by buying or selling
>bonds?  How does this work?   They bid high on t-bills,
>thus drawing money from banks?  Why do the banks have
>to sell?  And wouldn't they have to pull huge amounts
>in to make any difference?

No one really knows how, or sometimes even if, a central bank 
influences an economy. And while raising interest rates can slow an 
economy down, it may take pretty dramatic increases to take effect - 
and it's hardly a dead certainty that lower rates will stimulate an 
economy. They usually do, but not always. As for the money supply, 
they can try, but a lot depends on whether people want to borrow 
money and/or banks want to lend it to them. Again, it's easier for a 
c.b. to slow things down than it is to speed them up.

Doug