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Interest rates must tell the truth



By Richard M. Ebeling

In mid-July 2018, President Donald Trump said in an interview that he was "not happy" that the Federal Reserve is boosting interest rates and threatening economic growth in the United States. At the recent meeting of global central bank chiefs in Jackson Hole, Wyoming, Federal Reserve Chairman Jerome ("Jay") Powell said the Fed's board will continue to act independently of policy and raise interest rates to ensure a stable economy limited price inflation.

Lost in bartering was a simple question: should it be the job of a central bank to target or fix interest rates, or should this be the task of the market forces of supply and demand, as with another price in the economy?

Market Prices Coordinate Supply and Demand

Let us remember what market prices are supposed to do. First, they should bring the two sides of a market in a coordinated balance – that is, reconcile the buying plans and wishes of willing buyers with the production and sales plans and wishes of willing suppliers.

If a price is too high, it means that the quantities of good that the producers offer on the market are too high for the buyers to be willing and able to buy everything that is delivered. With a surplus of unsold stocks in excess of the planned level, sellers are reducing the price of the item competitively to encourage buyers to buy more.

If the price is too low, this means that the quantities of each good are profitable for the producers to offer on the market are less than the amounts that interested and willing buyers want to buy. This scarcity of a commodity tends to increase prices, causing sellers to produce and market more of them.

Market prices arise from a discovery process

For example, competitive price movements are being pushed up or down bringing down the necessary buy and sell adjustments to rebalance the coordinated balance in and between the markets. But how much should prices adjust in one direction or the other? The answer is that no one knows about the actual offers and offers from buyers and suppliers. Anyone willing to buy or sell more of the good can only be discovered through the actual competitive market process.

The reason for this is that buyers and sellers on both sides of the market are not following in their heads with detailed buying and selling plans, how much they would buy or sell from different goods at different prices. People sort this out only in their own minds when they make buying and selling decisions in changing circumstances and have to choose among the options available based on their customer satisfaction or producer profits.

In the economist's jargon, people only experience their own "preference scale" and ranking in selection. Therefore, unless people can predict their own buying and selling decisions in advance before making their decisions, it seems presumptuous to think that business observers and analysts have the ability to read other people's minds sufficiently to get the answers Knowing All This The same people have become self-reliant in all their mutual complexity.

Because the economic observers and analysts hardly differ from those who study them and whose market actions they want to predict. Typically, they only know and decide what they will do in the marketplace when making their buying or selling decisions, and therefore discover their own preferences for supply and demand.

What can or will this be? The competitive and co-ordinating price of a good and the actual quantities of supply and demand that can balance a market are not fully understood before the market process that produces it. This is the reason why the Austrian economist Friedrich A. Hayek described competition as a discovery process (see my article "Capitalism and Competition").

Prices as Means of Market Communication

Prices are also the market means whereby all persons involved in the division of labor can talk to each other about their willingness to buy and sell various goods and services. In their stylized models of "perfect competition" in economics textbooks, many economists assume that knowledge about supply and demand conditions in the market is already well-known to everyone or is available at no or low cost.

But the fact is each one of us Of all the billions of other people with whom we are directly or indirectly linked by the global division of labor In fact, how many of us know about the vast majority of people in our own city or community in terms of who they are, what they are working on, what their interests and desires may be or what they want and can join us in mutually profitable trades if they have their talents and abilities compared to our own? (See my article "Some confusions of language in economic thinking.")

So how should we find out the minimum necessary information to coordinate our desires and production capabilities with all of them? This is also the role of market prices. They serve as market-generated shortcuts in most cases, sufficient to find out what people want to buy and sell for a wide range of consumer and producer decisions.

In fact, if a network of competitive prices existed for virtually anything that could or could not be produced or marketed, it would be impossible for the level of complex and multi-level production activities that make up the majority of humanity in a global family market Connect improvement.

The prices of the recent past and the present day serve as the signals on which people are trying to make informed judgments about what others could buy and sell in the future when planning their consumption and production plans to look at a series of tomorrow (see my article "Capitalism and Expectations Coordinate Markets."

And that comes to another important role that prices play in the marketplace: the coordination of production activities over and through ti me in shape of multilevel supply chains of production, which connect many participants of the social system of the division of labor.

Coordinate today's production with the requirements of tomorrow's market

Another shortcoming in many of the popular business textbooks is the lack of emphasis on the type of production by the Time and the necessary coordination to a continuous flow of desired goods always available in the market to ensure. In fact, through such successful coordination of production processes over time, most consumers in society may forget that each production requires time for which there is always a production period before a desired product is available for purchase and use.

For simplicity's sake, suppose that there is a desired consumer good that requires five production phases before production is complete and the good is ready for sale. Suppose that each phase of the production process lasts one year, leaving a total waiting time of five years for the finished product.



In the above table, if the buyers want the product in question is available for purchase and use in 2023, the production process must begin in 2019. And if there are no deliveries of this good from previous production, the buyers have no choice but to wait until they go through each of the five one-year production stages and are then ready to be bought.

If this product is desired for purchase and use in every year after 2023, if the first quantities are still produced during the manufacturing year 2, it is necessary to be at the same time starting phase 1 of the same production process, so that also in the year 2024 the desired quantities are available.

If buyers want the same good to be in a certain quantity in 2025, the original production process must be in 2021 b. In Stage 3, the quantity that is desired in 2024 must be in stage 2 of manufacture, and the Quantity desired in 2025 must begin its first stage of production.

If this process is continuous, then each of the five stages in 2024. At the same time, work is underway to ensure uninterrupted supply in the years to come. The production process, which started in 2020, will be in its final phase in 2024; the finished product for 2025 will be in Level 4; the product for 2026 will be in Phase 3 of completion; the product for 2027 will be in level 2; and the product for 2028 will begin in Stage 1.

Consumption can not be achieved without production time

If production is successfully coordinated over time in this way, the illusion can arise that there is no waiting time to obtain the finished end product that consumers want to buy. Production and consumption seem to occur at the same time, so it seems as if a time dimension of production is either irrelevant or does not exist.

However, this is only the case if market prices and investment decisions correctly match patterns of consumer demand at future dates, and when resources, including labor and capital, have been distributed in the correct order over each production period in each production process.

When a new car factory is built, the zealous buyer of a car When you come from the production line of this factory, you have to wait until all phases of the construction of the first vehicle along the conveyor belt are complete, and at the end a car will appear is ready to drive. But as soon as production is up and running after an initial period, new cars keep coming off the production line, just as other future cars will come back on the conveyor at various stages of completion and lead to salable vehicles. [19659030] Today's salable products are not the goods that are being built today. The product prepared today began its production process sometime in the past. And the product, whose production process is started today, will be completed and available only at a time in the future when its own multi-stage production process is completed.

In order for these complicated and interdependent production processes to be effectively coordinated, market prices must serve as a source of information when goods are needed and must be produced in their proper order; and serve as income and profit incentives that motivate private entrepreneurs to plan production, to buy or rent the necessary inputs, and to complete these time-consuming production processes.

Interest Rates and the Nexus of Savings and Investment

This brings us to where we started: whether markets or central banks should influence or set interest rates. Market-based interest rates are also the prices. They are designed to balance the willingness of some earners to compensate with the demand of others as borrowers to use these savings for future-oriented investments that produce desirable goods at different times in the future.

When the willingness of some to save is greater than the desire of others to borrow at a given rate to attract interested borrowers, the interest rate is lowered, which also reduces the incentive for some income earners to save as much as They originally planned to reduce available savings and induce some of these income earners to consume more or even make profitable investments in the present

If the willingness to borrow is greater than the willingness of income recipients to save on a particular interest rate, these borrowers will uplift the interest rate, leading some income earners to find it profitable, save more and consume less in the present. It will also reduce the amount of funds demanded by some borrowers, as the rising interest rate makes some investments less profitable to cause higher borrowing costs.

Similar to other competitive prices, market-based movements in interest rates balance the savings and investment sides of the market. How much should interest rates go up or down to bring about this coincidence between the two sides of the market? There is no way to find the answer to this independently of the decisions of savers and borrowers regarding the most profitable answers to the discovery that existing interest rates are unsustainable given the discrepancies between demand and supply.

Likewise, it is only through the network of market-based interest rates, where information is distributed and then integrated to simplify the plans of groups of potential savers and borrowers, separated in time and space. Only market-generated interest rates allow observers to compare those who are interested in savings with those who are interested in borrowing.

All this is made possible through the intermediation of financial institutions that bring together all the people on both sides of this market without approximating each of them – specific savers and specific borrowers – who ever know each other or motivate motivations to save something and invest others want.

Interest Rates Coordinate the Time Horizon of Investments

Finally, Market Interest The tariffs coordinate the intertemporal planning decisions of those who are considering or implementing investments in one of the phases of multi-period production processes. An interest rate not only informs potential borrowers of the cost of borrowing against a prospective rate of profit when an investment project is carried out, but also gives them the current value of possible investments from which to choose [19659043] For example, the present value of a Investment that pays $ 100 in 5 years from now at 2 percent interest, $ 90.50, while an investment pays $ 100, but only has a present value of $ 82 in 10 years at 2 percent interest. Let's say the interest rate drops to 1.5 percent. The present value of a $ 100 investment that pays off in 5 years increases to $ 92.80, while the investment, which replaces $ 100 in 10 years, rises to $ 86.10 at present value.

Thus, not only would market interest rates decrease Interest rates affect the profitability of prospective investment projects in general, but they would also (all things being equal) make longer-term (shorter term) investments appear more profitable with the decline (increase) in the interest rate , Thus, the production periods in which potential investments are made may be influenced by changes in market interest rates.

If market interest rates fall as a result of changes in people's saving preferences – that is, increase their savings and reduce their spending on their income – this will not only allow for more investment from a larger savings pool, but possibly also for investments with a longer duration to completion , That is, the time structure of the investment and not just the amount of additional investment can be influenced.

The Risk of Viewing Interest Rates as Political Instruments

Both Donald Trump and Federal Reserve Chairman Jay Powell do not see interest rates as market-based and market-generated intertemporal prices that serve to provide themselves with the information they generate as a response to changes in underlying real supply and demand conditions, and as a political tool to influence capital spending, the economy as a whole.

The focus is on production in general, employment in general and price levels in general. In other words, the focus is on all the standard macroeconomic aggregates that have dominated monetary policy since the Keynesian revolution of the 1930s.

But all these macroeconomic output and employment aggregates and price averages hide all the real relationships that underpin market demands and deliveries, and are kept in balance by the structure of relative prices and wages, of which market interest rates are central.

Just as the relative prices that link demand and supply to each other are changing Individual goods and services offered in the marketplace keep the different productions and resource uses in balance with consumer demand, and the same coordinating role is exercised by the market interest.

Market-based interest rates keep thrifty austerity decisions in balance lending and investment decisions. They distribute available scarce resources, including labor, from consumption-based production activities to longer-term investment purposes. They help determine the production periods that are profitable and allow the timing of production processes to be coordinated with those of future consumer demands for goods in the manner described above.

Fed interest rate policy has How a price control

The determination or influence of interest rates by the central bank is a form of price control that prevents the interest rates reveal the truth about savings preferences and the profitability of investments; Prevents this information from being shared with market participants, thus improving the coordination between available savings and investment opportunities; and may distort the time structure of the investment periods so that they are incompatible with the actual savings in order to preserve them given the structured sequence of when consumers want goods at different times in the future.

For most of the past 10 years, the Federal Reserve has used its monetary policy instruments to bring nominal interest rates close to zero. Adjusted for price inflation using the consumer price index as a rough indicator, most interest rates remained in negative territory for most of this period. That is, in terms of real purchasing power, the borrowing costs were, well, zero.

If the government sets a market price of or near zero, it basically lifts this up as a useful indicator of the actual demand for the commodity, and the possible deliveries thereof based on resource availability and the opportunity cost of its use for one or the other production opportunity instead ,

This means that it is not unlikely that conditions were created for a future economic downturn: interest rate misstatements; relative prices that do not match the underlying deliveries and requirements; Misallocations of investable capital and labor; and the discrepancy of some production periods with consumer demand and austerity decisions leads to prohibitive investments.

As long as politicians and central bankers consider it their business to manipulate market prices, whose interest rates are among the most important. Macroeconomic imbalances and discoordinations in the market economy will occur again and again. And undoubtedly, "capitalism" and the profit motive are ultimately labeled as the culprits, while the culprits always live and work in the halls of government offices and central banks.


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