What if I told you we could have strong wage growth, a robust social safety net, affordable housing, and a dynamic high-productivity economy, all without inflation?
Well we can. We just can’t have all those things and have low interest rates. I’ve written about this from the other end — how stagnant wage growth and insufficient government spending caused central banks to cut rates, over the last 30 years, to record low after record low — money wasn’t flowing into the economy through wages or welfare, or not enough, so it had to enter as loans. This was never sustainable. Nor was it desirable.
Today I am making the inverse point; if you want wage growth in real not just nominal terms, if you want to raise the rate of income support payments above the poverty line, if you want to properly fund hospitals and schools and infrastructure, if you want affordable housing, you need to embrace high interest rates.
Low interest rates are inflationary. So is government spending. So is wage growth. If the goal is to keep inflation steadily within its 2–3% band, then there’s a three way trade off. More of one means less space for the others. So maybe, during the pandemic, when wage growth fell away, we could have had the increase in government spending, or we could have had rate cuts. But in hindsight we know now we couldn’t have both.
Going forward, what do we want? Do we want wage growth and increased government spending? Or do we want low interest rates and ballooning asset prices, driving inequality further?
Yes, some people have overpaid for houses and will end up forced to sell at a loss. This is no doubt upsetting for them, and they have my sympathy. Higher rates will give us the fiscal space to take care of them and the people a class below them, who never had a shot at owning a home. We can build public housing, invest in income support (ideally a basic income), we can reshore manufacturing and all that good stuff. But only if we raise rates — which are currently still negative in real terms — to an appropriately restrictive level.
There’s pain involved in this plan. But if someone can tell me a plan that doesn’t involve any pain for anyone, I would love to hear it. Given the inevitability of a crisis we are already in, the question is how do we share the pain around most fairly. Keeping rates low means keeping wages and welfare payments low — punishing those who were never rich enough to take on big debts, shrinking their spending power even further with inflation. Raising rates means punishing those — asset owners and businesses — who chose to take on large debts.
It’s worth noting here the similarities and differences between the point I am making and that made by the Modern Monetary Theorists. They argue, correctly, in my opinion, that the real constraint on government spending is not tax revenues, but inflationary pressures. They would agree that we have pushed past those constraints. But they wouldn’t agree with raising rates. Like mainstream economists, they believe there is such a thing as a “natural” or “neutral” rate of interest. Their galaxy-brain take on this, though, is that this natural rate is 0%.
So their theory is that the government should be a money faucet, and so should the financial sector. Mine is that the government should be the faucet, spending more than it taxes, and the financial sector should be the drain, taking in more than they lend out.
In this ideal system money would flow into the economy in terms of government spending, and out as interest payments to banks (and ultimately to the central bank). Along the way, it would animate the economy — like water flowing through a hydroelectric turbine or a watermill, and, crucially — out the other end.